Not Legal Advice, 1 December 2019 – Stablecoins, North Korea, and Guns

Welcome back to Not Legal AdviceIt’s been two weeks since the last update, so there’s no point wasting time with a long preamble – let’s get right down to it. This week:

  1. FinCEN issues stark warning to stablecoin administrators.
  2. Ethereum Foundation Head of Special Projects, former Enterprise Ethereum Alliance Mainnet Working Group Chair accused of assisting North Korea to evade sanctions
  3. Supreme Court denies cert in a Section 230 Communications Decency Act case,  Daniel v. Armslist, No. 2017AP344 (Wis. Ct. App. Apr. 19, 2018)

1) FinCEN issues stark warning to Stablecoin administrators

Not much to say here except that FinCEN has fired a shot across the bow of MakerDAO or similar schemes which hold themselves out as decentralized protocols, but also carry out money transmission-like functions. From FinCEN Chairman Kenneth Blanco:

“Because we are technology-neutral, we can say with complete clarity that for AML/CFT purposes, it should be understood that transactions in stablecoins, like any other value that substitutes for currency, are covered by our definition of ‘money transmission services’,” Blanco said.

“This means that accepting and transmitting activity denominated in stablecoins makes you a money transmitter under the [Bank Secrecy Act]. It does not matter if the stablecoin is backed by a currency, a commodity, or even an algorithm – the rules are the same. To that point, administrators of stablecoins have to register as [money services business] with FinCEN.”

Pretty stark. However, seeing as no regulatory action has been brought against a stablecoin to date (apart, perhaps/unconfirmed, from Basis, which shuttered its doors rather than launch) whether any particular unlicensed stablecoin is determined to be money transmission, and on whom the liability for operating it will fall, remains to be seen. Although FinCEN will have a lot of options if they choose to wade into the paddling pool. As I put it on Twitter:

2) Ethereum Foundation Head of Special Projects, former Enterprise Ethereum Alliance Mainnet Working Group Chair accused of assisting North Korea to evade sanctions

From the DOJ:

[Virgil Griffith is accused of violating the] International Emergency Economic Powers Act (“IEEPA”) by traveling to the Democratic People’s Republic of Korea (“DPRK” or “North Korea”) in order deliver a presentation and technical advice on using cryptocurrency and blockchain technology to evade sanctions. GRIFFITH was arrested at Los Angeles International Airport yesterday and will be presented in federal court in Los Angeles later today…

…As alleged, Virgil Griffith provided highly technical information to North Korea, knowing that this information could be used to help North Korea launder money and evade sanctions. In allegedly doing so, Griffith jeopardized the sanctions that both Congress and the president have enacted to place maximum pressure on North Korea’s dangerous regime.

…Despite receiving warnings not to go, Griffith allegedly traveled to one of the United States’ foremost adversaries, North Korea, where he taught his audience how to use blockchain technology to evade sanctions. By this complaint, we begin the process of seeking justice for such conduct.

Whilst Griffith is innocent until proven guilty, the complaint doesn’t look great. Griffith apparently posted about his visa application process and intent to travel to North Korea publicly on his Twitter account. Other members of the Ethereum community failed to challenge and, in some cases, encouraged Griffith to make the trip. Griffith voluntarily consented to not one, but two interviews with the FBI, presumably without the assistance of counsel, in which he, among other things, admitted the conduct, admitted he intended the conduct and admitted he wanted to renounce his U.S. citizenship.

U.S._Marines_in_the_Korean_War_003
A photograph of brave U.S. Marines fighting to save democracy in Korea, in case Ethereum people need a reminder of which side they’re supposed to be on.

There are really only three things I have to add to this.

First: anyone who made a lot of money in Ether should understand that just because you made one good investment back in 2014, and haven’t had to do any real work since, doesn’t mean you are a polymath. More likely (but certainly not in all cases), you’re a dumbass and you got lucky. Somewhere, out there, your doppelgänger mortgaged his house twice to invest in Algorand shortly after it listed on Binance. He was ruined. You were not.

This is not to begrudge your legal if not moral entitlement to your wealth, which you won with a roll of the dice, fair and square. It is simply to say that however clever you may think you are, you are not clever enough to go toe-to-toe with the FBI without the assistance of counsel. No one is.

Second, this is an appalling governance failure by the Ethereum Foundation and the Enterprise Ethereum Alliance, two organizations principally concerned with promoting the adoption of the Ethereum cryptocurrency, and in which Griffith apparently held senior positions.

From what I can glean from the indictment, the purpose of the trip was principally to market Ethereum to the North Koreans as a sanctions-evading tool. Yes, North Korea using your coin will drive up demand for that coin. But it’s North Korea. Someone should have prevented Griffith from making this trip. Someone should have told him his position would be untenable if he went. The Ethereum community, its organizational bodies, and its leadership should have, when faced with the choice between the United States and North Korea, unapologetically and emphatically chosen the United States.

That’s not what happened.

There are things more important in this world than getting your favorite coin to the moon. Crypto is a high risk business as it is and private companies, consortia and nonprofit foundations alike need to be mindful of increased exposure arising due to the actions of rogue senior employees who wander off the reservation.  If someone in your organization is going to do something like this, no matter how much crypto he might hold, no matter how much of an OG he might be, tell him “no.” If for whatever reason he insists on continuing, fire him.

Third and finally, all that remains, as with other federal criminal proceedings against early Ethereum participants such as Stephen Nerayoff, is to watch this play out.

3) Supreme Court denies cert in a Section 230 Communications Decency Act case, Daniel v. Armslist, No. 2017AP344 (Wis. Ct. App. Apr. 19, 2018)

Armslist was a big Section 230 case in which a gun marketplace website which is basically “Craigslist for Guns,” Armslist.com,  was sued by the survivors of a victim of a shooting that involved the use of a gun purchased through the site.

Plaintiff Daniels lost at first instance, won on appeal, and lost again at the Wisconsin Supreme Court. Last week SCOTUS denied cert, ending the case.

As told by the plaintiff’s cert petition, the plaintiff alleged that:

after years of threats and violent abuse, Zina Daniel Haughton (“Zina”) obtained a domestic abuse restraining order against her estranged husband, Radcliffe Haughton (“Haughton”). The order, issued by the Milwaukee County Circuit Court to protect Zina, prohibited Haughton from possessing a gun, and made him a “prohibited” firearms purchaser under federal and state criminal laws. But Haughton knew how to easily circumvent the law and the order. He went on the Internet and visited Armslist.com. Armslist.com is an online gun marketplace specifically designed to facilitate the illegal purchase of firearms by people like Haughton, who the law forbids from buying guns.

Note: the contention that Armslist is intentionally designed to facilitate unlawful firearms transfers is both material and disputed. Assume for the moment what the Wisconsin Supreme Court found, which is that Armslist is intended to be used for lawful commerce in arms, even if site users are able use it for unlawful purposes.

But I digress. The plaintiff continues:

As intended by Armslist.com’s negligent and intentional design features, Haughton found a person willing to sell him a gun, Devin Linn (“Linn”), and quickly and easily obtained a handgun and three high-capacity magazines in an all cash deal consummated in a McDonald’s parking lot three days after the restraining order was issued. The next day, Haughton used the gun he purchased via Armslist.com to murder Zina and two of her coworkers and wound four others before killing himself.

For this, the plaintiff sued Armslist, alleging numerous tort claims “including, inter alia, negligence, negligence per se – based on the violation of firearms laws – negligent infliction of emotional distress, civil conspiracy, aiding and abetting tortious conduct, public nuisance and wrongful death.”

Background: the law relating to buying a gun

There’s a lot to unpack here, particularly for my overseas readers, so let’s provide a bit of background before we continue. I preface this with the warning that this column is called Not Legal Advice for a reason, so the following is definitely, 100% not legal advice, as indeed nothing on this site is legal advice. I charge for that, and if I haven’t charged you, it’s not advice.

America is well known for being one of the few countries in the world which has very strong legal protections for civil rights as envisioned in the Enlightenment, including free speech, the right to be free from unreasonable searches and seizures, and the right to civilian firearms ownership.

The primary legal rule which protects firearms ownership in the United States is the Second Amendment to the U.S. Constitution, ratified in December 1791, which states that “a well-regulated militia, being necessary for the security of a free state, the right of the people to keep and bear arms shall not be infringed.” Much ink, digital and otherwise, has been spilled over the centuries about this legal provision; the law, as stated in District of Columbia v. Heller 554 U.S. 570 (2008), is that this provision generally protects an individual right to own firearms in common use. The “militia” language which many a commentator foreign and domestic get hung up on has been ruled prefatory, not operative, and does not operate to restrict what the Court has deemed to be an individual, and not a collective, right.

This does not, however, mean that firearms ownership in the U.S. is a legal free-for-all where any man can own any weapon and use it in any manner he pleases. In fact, firearms ownership and use are very tightly regulated, although regulations can be more or less stringent depending on what state (and in some exceptional cases, such as New York or San Francisco, what city) one finds oneself in.

Generally speaking there are two layers of regulation, mirroring America’s two layers of sovereignty: federal, which primarily concerns itself with interstate transactions in firearms, and state-level, which must apply the federal rules for transactions in interstate commerce, but are free to adopt less stringent regulations for transactions which occur entirely within their own borders.

The principal federal rule on firearms transfers that one encounters in daily life is found at 18 U.S. Code § 922(a)(1), which states in relevant part that

“It shall be unlawful— (1)for any person— (A) except a licensed importer, licensed manufacturer, or licensed dealer, to engage in the business of importing, manufacturing, or dealing in firearms, or in the course of such business to ship, transport, or receive any firearm in interstate or foreign commerce”.

The short version of 922(a)(1) is this:

  • if you sell a gun across a state line, you do so as a regular business or trade, and you don’t have a federal firearms license (an “FFL”, which acronym is used to refer to both the license and licensees interchangeably) you’re going to jail.

Then there’s 922(a)(5), which states it is a crime:

(5) for any person (other than a licensed importer, licensed manufacturer, licensed dealer, or licensed collector) to transfer, sell, trade, give, transport, or deliver any firearm to any person (other than a licensed importer, licensed manufacturer, licensed dealer, or licensed collector) who the transferor knows or has reasonable cause to believe does not reside in (or if the person is a corporation or other business entity, does not maintain a place of business in) the State in which the transferor resides; except that this paragraph shall not apply to (A) the transfer, transportation, or delivery of a firearm made to carry out a bequest of a firearm to, or an acquisition by intestate succession of a firearm by, a person who is permitted to acquire or possess a firearm under the laws of the State of his residence, and (B) the loan or rental of a firearm to any person for temporary use for lawful sporting purposes;

Short version:

  • If you’re a private seller you can’t transfer a gun to someone who isn’t a resident of your state, unless it’s part of a decedent’s estate and the transfer is being effectuated pursuant to a will or intestate succession.

Then there’s also 922(b)(3), which states

(b)It shall be unlawful for any licensed importer, licensed manufacturer, licensed dealer, or licensed collector to sell or deliver—
(1)any firearm or ammunition to any individual who the licensee knows or has reasonable cause to believe is less than eighteen years of age, and, if the firearm, or ammunition is other than a shotgun or rifle, or ammunition for a shotgun or rifle, to any individual who the licensee knows or has reasonable cause to believe is less than twenty-one years of age;
(2)any firearm to any person in any State where the purchase or possession by such person of such firearm would be in violation of any State law or any published ordinance applicable at the place of sale, delivery or other disposition, unless the licensee knows or has reasonable cause to believe that the purchase or possession would not be in violation of such State law or such published ordinance;
(3)any firearm to any person who the licensee knows or has reasonable cause to believe does not reside in (or if the person is a corporation or other business entity, does not maintain a place of business in) the State in which the licensee’s place of business is located, except that this paragraph (A) shall not apply to the sale or delivery of any rifle or shotgun to a resident of a State other than a State in which the licensee’s place of business is located if the transferee meets in person with the transferor to accomplish the transfer, and the sale, delivery, and receipt fully comply with the legal conditions of sale in both such States.

Short version:

  • An FFL can’t sell a handgun to anyone under 21 or a rifle to anyone under 18.
  • An FFL can’t sell someone a firearm to a resident of another state if they’re not allowed to have it pursuant to the laws of that state, i.e. a resident of Connecticut cannot drive to New Hampshire and buy an AR-15 from an FFL.
  • An FFL can’t sell a handgun to someone who doesn’t reside in their state, although they can sell a rifle or shotgun if (a) the buyer meets with the FFL in person and (b) the sale would be kosher in both states.

All these rules mean the process of selling guns across state lines can be a little clunky. By way of worked example, Alice Atlanta is a hobbyist collector of firearms. If Alice Atlanta wants to sell a handgun – let’s say a Glock 19, arguendo – to Bob Birmingham, Alice would need to

  • transfer the firearm to an FFL in Georgia,
  • the Georgia FFL would need to ship the firearm to an FFL in Alabama, and
  • Bob would need to acquire the firearm directly from the Alabama FFL.

Ordering from an online store similarly requires the online store to transfer to an in-state FFL of the recipient, rather than shipping direct to the recipient, and the in-state FFL will then customarily charge a handling fee to the ultimate purchaser on top of the purchase price.  If Alice transferred the firearm to Bob on the sly in a parking lot in Gadsden, Alice would be breaking the law. If Alice were actually running a business out of the back of her car, and not just a mere hobbyist, she’d be breaking two laws.

Another federal rule involves background checks. Specifically, 18 U.S. Code § 922(t), which states in relevant part that 

a licensed importer, licensed manufacturer, or licensed dealer shall not transfer a firearm to any other person who is not licensed under this chapter, unless— (A)before the completion of the transfer, the licensee contacts the national instant criminal background check system [note: known as “NICS”] established under section 103 of that Act; (B) (i) the system provides the licensee with a unique identification number; or (ii) 3 business days (meaning a day on which State offices are open) have elapsed since the licensee contacted the system, and the system has not notified the licensee that the receipt of a firearm by such other person would violate subsection (g) or (n) of this section; and (C)the transferor has verified the identity of the transferee by examining a valid identification document (as defined in section 1028(d) of this title) of the transferee containing a photograph of the transferee.

Short version:

  • if you are the recipient of a transfer of a firearm from an FFL you need to present photo ID and you either need to (a) pass an instant background check through NICS, the national criminal database, or (b) NICS needs to fail to come back with an answer within three business days of asking NICS whether you’re legally allowed to own a gun, before you can take possession of that gun.

Acting in concert, what these provisions do is require any interstate transfer to go through an FFL and pass a background check.

When a gun doesn’t cross a state line, however, this is not currently the province of the federal government, but rather it is a matter for the states. Even if the federal government could constitutionally assert jurisdiction over intrastate transactions (which, given the historically overbroad application of the Commerce Clause, it probably could) there simply hasn’t been the political will to do it for over 50 years. As a consequence, states have different and highly varied rules around firearms transactions that occur within their own borders.

I am not a Wisconsin lawyer, but Wisconsin’s rules, according to the Giffords Law Center, allow private sellers to transfer firearms between one another without performing a background check, which is completely legal federally as long as a state line isn’t crossed.

Armslist is, for the purposes of these transactions, like Craigslist, a classifieds site, which doesn’t perform diligence on the postings made on it. It matches the buyers and sellers, but does not perform any diligence or enforce specific compliance rules for each transaction. It is conceivable that all of the transactions on Armslist are legal; it is up to the users to actually put in the work to comply with local and federal laws, which they often do not, with attendant state and federal consequences.

Back to Daniels’ (failed) attempt to disapply Section 230 in Armslist

But Armslist is being sued here, not its users. Daniel argued that Armslist should be held liable for users’ misdeeds as it was providing its services in bad faith, in that

Armslist designed the site to easily facilitate firearms sales for otherwise prohibited possessors, like Zina’s husband. For example, she alleged that Armslist allows a prospective purchaser to filter sellers to find “private sellers” that are not required to perform background checks before selling firearms. Nor does the website require users to create accounts but instead allows them to operate anonymously. She also alleged that Armslist does not take action to delete illegal or unlawful posts.

Based on all these features and omissions, Daniel’s complaint alleges that Armslist knew or should have known that its website would put firearms in the hands of dangerous, prohibited purchasers, and that Armslist specifically designed its website to facilitate illegal transactions.

Armslist invoked Section 230 of the Communications Decency Act (“Section 230”) in its defense.

I have written about Section 230 before. Section 230 is a provision of federal law that says, broadly, two things:

  • In Section 230(c)(1), platforms and users of those platforms are not liable for content created by other users (known in the statute as “Information Content Providers”).
  • In Section 230(c)(2), platforms are immune from liability for making good-faith moderation calls that result in material being removed from the platform.

Armslist is principally a Section 230(c)(1) action.

Those of you new to Section 230 should note that the immunity is very specific. It does not confer legal immunity upon a website simply because they are websites, as politicians like Sen. Josh Hawley falsely claim to push ill-conceived laws through Congress. Rather, it confers civil immunity and immunity from state laws for user-generated speech that  is posted on their platforms but which the website did not itself make. So, by way of example:  

  • Let us stipulate that rap megastar Dr Dre was born to human parents in Compton, Los Angeles County, USA, on 18 February, 1965.
  • Dre protégé and fellow rap superstar Snopp Dogg, also born and raised in L.A. County, maliciously accuses Dr Dre of being a Martian – i.e., an alien from the planet Mars – in a Facebook post, despite knowing that Dre was born in L.A. County. Dr Dre sues Snoop Dogg and Facebook for defamation. Facebook would be immune from Dre’s suit, thanks to Section 230.
  • Snoop Dogg accuses Dr Dre of being a Martian in a post on Facebook. Facebook issued a press release saying that it believed Dr Dre is in fact from the planet Mars, which is untrue, as Dr Dre is from Compton. Dre sues Snoop Dogg and Facebook for defamation. Facebook would not be immune from Dre’s defamation suit for the press release.

Those are extreme/clear cut examples. But what happens, for example, when:

  • Snoop Dogg takes out an ad on Facebook saying “Dr Dre is a Martian.” and Facebook  Ads representatives respond that referring to someone as a Martian is hate speech and suggest using the term “extraterrestrial” instead. Dre sues Snoop Dogg and Facebook for defamation.

OR

  • Snoop Dogg takes out an ad on Facebook saying “Dr Dre is…” and Facebook has a pre-populated group of personal characteristics including “tall,” “a good rapper,” “a regular reader of the Financial Times” and “a Martian.” Snoop selects the “Martian” option and Facebook runs the ad. Dre sues Snoop Dogg and Facebook for defamation.

Tricky, right? In each case Snoop Dogg initiated the ad buy, Dre was defamed, and Facebook contributed to the content, even though it did so at the behest of the user and the user was responsible for the final sign-off of the published messaging. Under the right circumstances, this might be enough for Facebook to become an “information content provider” with respect to the statement – “information content provider” being defined as, per Section 230(f)(3),

any person or entity that is responsible, in whole or in part, for the creation or development of information provided through the Internet or any other interactive computer service. (emphasis added)

…and if Facebook is an information content provider, the Section 230 shield falls away. See e.g. FTC v. LeadClick Media, LLC, 838 F. 3d 158 (2016). In Leadclick an affiliate-marketing business which displayed deceptive advertisements was found liable for statements made in those fake advertisements because they provided feedback on the content of the advertisements. For example, “[making] a false advertisement [for a dietary supplement] appear ‘more realistic’ by lowering the amount of falsely claimed weight loss.” Even if a site isn’t the principal author, affirmatively developing user generated content created by someone else can be enough to make the Section 230 immunity fall away.

This principle extends to a website’s UI, even if the website isn’t affirmatively “saying” anything in the way that one might commonly understand the term. See Fair Housing Council of San Fernando Valley v. Roommates.com, LLC, 521 F.3d 1157 (9th Cir. 2008).

Roommates.com is a website which advertises room rentals. At one time, Roommates required users to “disclose their sex, race, sexual orientation, and whether they will bring children to the household in order to use the site” in drop down menus. Roommates also provided an “additional comments” box where providers of housing could specify their preferences for renters (e.g. “black males only,” “no children”).

Racial discrimination in housing is, of course, hugely illegal. When the Fair Housing Council sued Roommates, the case worked its way up through the courts until the 9th Circuit, sitting en banc, definitively disapplied the Section 230(c)(1) immunity for one aspect of the UI but upheld it for another. The court held that while Roommates was not liable for the (entirely user-generated) comments in the “additional comments” box, they were liable for the display of the protected characteristics of prospective renters from the mandatory drop-down menus and the discrimination that this information enabled. Put another way, when the website pre-populated the choices users could complete in the drop-down menus, the website, not the user, was doing the talking. And if that speech had legal consequences, Roommates could be sued for it. As Judge Kozinski put it in his majority opinion:

Roommate created the questions and choice of answers, and designed its website registration process around them. Therefore, Roommate is undoubtedly the ‘information content provider’ as to the questions and can claim no immunity for posting them on its website, or for forcing subscribers to answer them as a condition of using its services.

Armslist qua speaker: a business that walks right up to the line, but stays on the right side of it

There are two problems with going after Armslist, then. First is that nothing about what Armslist qua Gun Craigslist does is illegal under federal law. It is also entirely feasible that every single one of its users could use the site to engage in lawful transactions. As the Wisconsin Supreme Court put it,

Armslist.com’s provision of an advertising forum and the related search functions are all “neutral tools” that can be used for lawful purposes. Sales of firearms by private sellers are lawful in Wisconsin. Further, private sellers in Wisconsin are not required to conduct background checks, and private sales are not subject to any mandatory waiting period. Accordingly, the option to search for offers from private sellers is a tool that may be used for lawful purposes…

Second and furthermore, Armslist didn’t “develop” the content users posted on the site, legal, illegal, or otherwise.

Despite the plaintiff’s assertions that Armslist was “specifically designed to facilitate” illegal arms transfers, the Communications Decency Act is specific: per the Wisconsin Supreme Court, “an interactive computer service provider will not be liable for providing neutral tools ‘even if a service provider knows that third parties are using such tools to create illegal content.'” Intent or knowledge are irrelevant since Armslist isn’t itself an information content provider, said the Wisconsin Supreme Court. The question when inquiring about Section 230(c)(1) is limited to “whether Armslist materially contributed to the unlawfulness of the third party content” such that Armslist itself became the information content provider.

The downfall of websites from Backpage to LeadClick is that site operators, keen to ensure that goods and services marketed on them appeal to users no matter how illegal those services might be, have been lured into messing with user-generated content in order to “improve” the user experience. In doing so they lower their Section 230 shield and expose themselves to civil and criminal penalties.

Armslist appears to have successfully resisted this temptation. If it hadn’t, Daniels might have been able to penetrate the Section 230 shield. But Armslist didn’t get involved with the post in question. Armslist was not an information content provider and could not therefore be civilly liable for the torts of the user, per the Wisconsin Supreme Court. Last week SCOTUS declined to overturn that decision.

A denial of cert doesn’t necessarily mean that SCOTUS agrees or disagrees with the Wisconsin court’s ruling. But it might suggest that the high court is aware of the strength of Section 230 to protect websites from litigation initiated by persons unhappy with the conduct of the sites’ users, and is in no mood – or finds no grounds – to overturn it. Entrepreneurs running their own websites should be aware, however, that Section 230 has limits and Armslist – a business that operates in an exceedingly high risk area – only escaped by not exceeding those limits.

How might have Armslist have gotten itself into trouble? Well if, like Roommates, its user interface made specific provision for illegal content, that might have been enough. For example: “Search for sellers willing to sell to prohibited possessors.” (For avoidance of doubt, Armslist has no such search function.) Or, like LeadClick, Armslist might have suggested changes to the wording of advertisements. Or Armslist might have developed an in-house seller ranking system that was not purely user-generated.

Long story short, if you’re running an interactive computer services business and some of your users are breaking the law, (a) discourage lawbreaking as much as you can, (b) cooperate with law enforcement, (c) make sure you don’t violate federal law and (d) let your users do the talking – resist the temptation to tweak user-generated content to make it look pretty. You’re a platform provider, not a seller. And, once again, this is not legal advice. If you need advice of this nature, you need to discuss your specific facts and circumstances with a licensed attorney in your jurisdiction.

Not Legal Advice, 18/11/2019 – The federal government needs to stop using the word “decentralization”

Welcome back to another edition of Not Legal Advice

One of the issues with a weekly blog series is that it is easy to get out of the habit of writing it if you miss one or two. Last week I was slammed traveling all over the East Coast so I didn’t have a ton of time to read or write – although running a solo practice is great, arguably the biggest downside is that you can’t delegate – meaning that clawing back time to write can be a challenge.

But dammit, I’m going to do this every week. This week, I have only one thing to talk about. And that’s the fact that the federal government can’t make up its mind about how to deal with Ethereum.

For those of you just joining the conversation, Ethereum is a cryptocurrency that was created following a $20 million initial coin offering, or ICO, in 2014, in which approximately 70% of the outstanding supply of the coin was sold.

Despite the fact that Ethereum was run in exactly the same way as every ICO the SEC has enforced against, in 2018 the SEC punted on regulating Ethereum following an intense lobbying campaign by Coin Center and other industry participants.

This year, the new Chairman of the CFTC Heath Tarbert has said the Ethereum-where-70%-of-the-tokens-were-sold-in-an-ICO-scheme is also not a security but a commodity falling under his jurisdiction. This was only last month.

Now, we are told, the planned migration of the scheme from proof of work to proof of stake will render the scheme, potentially, a security. CFTC Chief Heath Tarbert:

“Mining is, by its very nature, more decentralized as compared to a stake which reduces energy costs by giving it just one validator or a line of validators,” Tarbert said in response to a question whether ether 2.0 will be classified as securities.

This led to the somewhat unsatisfactory position that, in the eyes of the SEC and CFTC, something could start life as a security, transmogrify into a non-security, and then transmogrify back again after a code fork.

Where is the government coming up with this? Probably from the decentralization bros with a lot of money to spend on lobbying, such as Coin Center.

Ethereum bros of course, not to be outdone, swiftly retorted that mining was in fact the more centralized scheme because it costs money to… buy mining equipment?

“In ethereum’s PoS, the capital that you need to acquire to participate is much more readily available. … Converting capital into an asset that allows you to stake in the protocol is much cleaner.”

*silent screaming*

Where to begin with this. To start, there is no agreed-upon definition of “decentralization” anywhere. Anyone who says that there is such a definition has an agenda to push. And to the extent that the term means anything it’s a relative definition rather than a description of an irreversible, apotheotic end-state.

Mining may be accurately described as decentralized, if there are a wide range of validators distributed geographically widely, and there’s something to compare it against. So, e.g., we might say “the Bitcoin network’s mining is more decentralized than the Ripple Network’s validator nodes.” But Ripple might retort by arguing that “more than 50% of the Bitcoin network’s hashppower is controlled by 3 mining pools, whereas our UNL is more widely distributed.” I wouldn’t buy that argument, but it’s one that could be made. Which argument is correct or not depends on what your assumptions are.

Similarly, a network where stake is widely distributed and which requires a 7-out-of-10 vote to append a new block, such as a Tendermint node, might well be more decentralized than either if enough small validators band together to run the network on their own. What if we start out with four thousand stakers and gradually a handful, say one hundred, buy up most of the outstanding stake? Well then it might have fewer validators than Bitcoin and more than Ripple, but more “pools” than Bitcoin and fewer independent operators than Ripple.

All of these statements are correct in their own way. They’re all contradictory in their own way, too. Which indicates, at least to me, that using “decentralization” as a metric to determine whether something is or is not an investment contract – as the much-vaunted Hinman Test seeks to do – really is not a good idea, because nobody knows what the word means. Yet our regulators keep using this word, and coin bros keep encouraging them to, because asking whether a system is truly decentralized or not is like asking how many angels can fit on the head of a pin. Decentralization is a relative measurement, not a platonic ideal.

Now perhaps – and bear with me here – a better measure of determining whether a scheme is or isn’t an investment contract is to look at how the scheme began and, where there’s a premine which is pre-sold, a view is taken as to the nature of the instrument arising therefrom. Schemes like Bitcoin which arise from work and boot-strapping fall outside of the regulatory perimeter and schemes that do otherwise do not.

Such an approach would be consistent with most of the enforcement which has occurred to date. It would not be consistent with the treatment of Ethereum, for indeed nothing is consistent where Ethereum is concerned, and that confuses the hell out of everyone.

The “decentralization” test confuses the market and is not fit for purpose. Nobody knows what “decentralization” means. Even if we did, as I mentioned, decentralization is a relative rather than absolute measure.

Absolute measures create certainty in the marketplace. And although Howey is not absolute, I can think of one absolute measure which would be entirely consistent with the SEC’s enforcement and coin schemes’ compliance attempts to date – entirely consistent, that is, if Ethereum had been brought into the regulatory perimeter instead of being treated as some kind of outlier. Treat presales of coins (not coupons) as dispositive and abandon the idea that something can start life as a security, transmute into a non-security and then, as a consequence of a code fork, revert back again – which is the current view of the regulators.

As I always say when this issue comes up, I know of no precedent for this anywhere in American law and have yet to have anyone point one out to me in six years of asking this question.

And here is a picture of a marmot.

groundhog-4289456_960_720.jpg

Not Legal Advice 11/9/19 – Dai hits $100 million; Crime doesn’t pay; FBI Director Wray speaks to Congress

Welcome back to this week’s edition of Not Legal Advice!

Once again, I’ve been remiss in typing up my weekly newsletter on a weekly basis due to travel – one of the downsides of solo practice is that one has no minions to dispatch to the far sides of the world – and this time, to San Francisco, where I did a panel with the inimitable Josh Stein of next-gen digital securities firm Harbor, among others, at SF Blockchain Week. Well done to the organizers for putting on a great conference.

This week’s a short one, as there really hasn’t been a whole lot in the last 14 days that I’ve found particularly interesting:

  • Dai hits $100 million in outstanding CDP contracts; crypto bros still don’t understand risk
  • Crime doesn’t pay: an update on the Brian Haney arrest
  • FBI Director Christopher Wray talks crypto to Congress.

1) Dai hits $100 million in outstanding CDP contracts; crypto bros still don’t understand risk

The Block reports:

The number of outstanding Dai has reached the protocol’s built-in “debt ceiling” of 100 million— an all-time-high for the nearly two-year-old stablecoin project. CDP 15336 minted the Dai that boosted the outstanding supply to its limit.

MakerDAO, the issuance platform behind Dai, had an original Dai debt ceiling of 50 million, which was raised to 100 million in July 2018. The MakerDAO team and community members plan to execute a governance vote this Friday to raise the debt ceiling by an additional 10-20 million.

Yes, a “decentralized stablecoin protocol” has “governance votes.” I’m not sure either.

The Block continues:

Early last week, the Maker Foundation announced that it will be rebranding its Collateralized Debt Position (CDP) in preparation for its November 2019 Multi-Collateral Dai (MCD) release. The new user interface of the Maker Protocol after the release of MCD will label CDPs as “Vault.”

What is “Dai,” I hear you ask? Dai is a so-called “stablecoin,” a cryptographic token which is designed to always hold a peg to a fixed, external unit of account – in Dai’s case, the U.S. dollar.

Dai accomplishes this, we are told, through a series of smart contracts on the Ethereum blockchain which issue the Dai coins and lock up an amount of Ether in excess of the Dai as collateral to back the “loan” which has been issued. This was known as a “collateralized debt position” but, perhaps because the organizers of the scheme have some dim awareness of the regulatory consequences of issuing securities which are backed by collateral pools and making them available for public sale, the Dai people are now changing the terminology of these smart contracts to “vaults.”

CDPs/Vaults expire in one of two ways. First, someone can pay back the Dai debt plus interest, which the scheme promoters misleadingly refer to as a “stability fee,” at which point the CDP dies and the locked Ether in collateral is returned. “Stability fees” can only be paid in MKR, another shitcoin which was issued by the original scheme organizers. In the alternative, if e.g. the value of the collateral pool is impaired, the CDP may be liquidated and the collateral used to repurchase Dai from the marketplace to ensure all Dai are backed by a quantity of Ether with a dollar value that is greater than or equal to the dollar value of all Dai in circulation.

How this works is a little complicated, but the team over at Reserve summarizes it well:

The process by which this happens is somewhat complicated. It involves two different on-chain auctions that try to raise enough capital to make the CDP debt free. To fully understand the process, you may have to spend some time thinking it through after reading it. If you don’t fully get it, don’t sweat it: full understanding is not necessary for following the rest of the analysis.

Here is how it works: first, a “debt auction” tries to repay the CDP’s debt through MKR dilution. The debt auction buys Dai, paying with newly minted MKR. The Dai is burned, to cancel the CDP’s outstanding Dai debt. The purpose of the debt auction is to ensure that the debt is repaid even if there is insufficient collateral in the CDP to repay the debt.

Simultaneously, a “collateral auction” buys MKR with the CDP’s collateral. The collateral auction sells enough collateral to cover the debt, accumulated interest (called the “stability fee”) and a liquidation fee. In Single-Collateral Dai, the liquidation fee is 13% of the collateral in the CDP — that is, they take 13% of the user’s locked up collateral capital when a user’s CDP gets auto-liquidated. The smart contract finally returns the remaining collateral to the CDP holder and burns all purchased MKR.

This is all, ultimately, just a complicated and extremely long winded procedure to repackage exposure to Ether in such a way as to drive demand for the MKR token. It is really only useful if you either (a) have a bunch of Ether and want to lever up and go long on more Ether or (b) you want to use a smart contract to obfuscate the source of your funds, which is something you really should not do.

The entire system is vulnerable to adverse movements in both ecosystems. As Dai is now expanding with “multi-collateral Dai” which is backed by many different kinds of coins, soon it will be vulnerable to adverse movements among a range of different cryptocurrencies.

The risk has not gone away. It has merely changed form. DeFi Bros have difficulty understanding this. e.g.

Current mood:

Long have I had suspicions about whether Dai is for real. My skepticism about the scheme before it launched was reinforced when the loss of one bot on one sketchy overseas exchange operated by an unnamed “third party market maker” resulted in the Dai dollar peg not just breaking, but shattering, until the bot was restored. Put another way, the brilliance of the Dai stablecoin system – at least back then – wasn’t the reason Dai held its dollar peg. A bot was.

And this isn’t me saying this. It’s the founder of MakerDAO, Rune Christensen.

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Put another way: back in 2018, the volume on busiest market in Dai by far, on a $1 million trading day, dropped to $300 when a single bot went down.

DeFi Bros struggle to understand why this is also problematic.

“In reality Dai remained stable on all other exchanges” is a worthless argument in that context. The context being that we just discovered that a huge chunk of the market was not bona fide trading. If most of the volume of the coin can be traded by one bot, were we wrong to trust the numbers before the bot was discovered? What reason do I have to trust the numbers now? What reason is there to trust the rest of that volume on other exchanges? How do I know they’re legit?

I’m not saying here that the MakerDAO team knows anything about these bot operations. Far from it. Indeed, Rune refers to a “third party market making bot.” A third party with whom I should greatly like to speak who, apparently, never decided to reveal him or herself to the world.

I don’t know who operated the bot. I also don’t know how the bot operator communicated this information about bots on Bibox (the exchange) to the wider world. I don’t know why they were spending all that time wash trading on Bibox or what they stood to gain from it. I don’t know why the wider crypto community and stablecoin bros alike were not the least bit distressed by this event. All I know is that it happened, and I have never seen an explanation for why the scheme should have worked when that bot was up yet it broke catastrophically when that bot was down, as occurred in January of 2018. In the last two years, journalists haven’t followed up.

What I do know is that there’s no magic or innovation in wash trading around a fixed price point to make a market look real, on the off chance that is indeed what’s going on.

Charts of derivatives that are repackaged exposures to Ether should look like they are repackaged exposure to Ether. Dai does not. In the eyes of a dispassionate observer this should raise questions about market integrity. When Dai first broke its peg in early 2018, daily trading volume was around $1 million and the total market cap was around $3 million. Now, daily trading volume has reached highs of up to $50 million. All of which is to say that to the extent that bot training wheels first put in place back in the day are still in place, those training wheels are being asked to hold up an increasingly large rider and will be placed under greater degree of stress.

I stand by my prediction, first made in 2017, that Dai will eventually implode. But for the bots, after it fell on its face in 2018 it would have stayed down, just like previous collateralized stablecoin schemes such as BitUSD and NuBits, both of which failed (in BitUSD’s case, it failed after five days). The bigger the scheme becomes, the more difficult it will be for Dai’s training wheels providers – mysterious figures in the shadows, operating bots that generate volume for fun and profit – to hold back adverse market movements.

If we learned anything about risk-obfuscating schemes from the global financial crisis, we know this: the bigger they get, the harder they fall.

2) Crime doesn’t pay: Silk Road trafficker pleads guilty

Breaking the law is bad and dumb. Breaking the law with cryptocurrency is exceedingly dumb. Hugh Brian Haney was arrested in July of 2019 in relation to Silk Road activity dating back to 2012; this week he pleaded guilty to two charges and now faces a maximum of 30 years in prison.

3) FBI Director Christopher Wray talks crypto to Congress.

Which brings us to our next news item. An interesting fusion of the crypto-means-cryptography universe and the crypto-means-cryptocurrency universe happened in Congress this week. As reported in CoinDesk:

Wray noted encryption is touching every aspect of emerging tech such as instant communications:

“Whether its cryptocurrency, whether it’s default encryption on devices and messaging platforms; we are moving as a country and world in a direction where if we don’t get our act together money, people, communication, evidence, facts, all the bread and butter for all of us to do our work will be essentially walled off from the men and women we represent.”

First, to clear something up: most cryptocurrencies DO NOT encrypt communications. Bitcoin is chief among these crypto-critters-that-don’t-encrypt-transactional-data. Bitcoin really only shields one bit of data – the private keys of the users – from government surveillance. But it doesn’t stop the government from tracking what different keyholders do and how funds on the Bitcoin blockchain move around.

Some privacy coins, such as Monero or ZCash, do encrypt transactional information. Opinions as to which method of encryption is superior and e.g. the merits of ZCash doing a weird international math druid ritual to generate the coin’s SNARK public parameters are legion and do not bear repeating here. What does bear repeating here is that it would be very foolish to presume that these encryption methods will be secure forever.

Second, we should be cautious before we throw encryption out the window. Crypto that can be defeated by the FBI can be defeated by anyone (which isn’t a dig at the FBI, it’s just reality – Fort Knox wouldn’t be safe if it had a secret, unguarded, publicly-accessible back-door, and neither is code under the same circumstances).

I have yet to watch the entire hearing (and will likely do so tomorrow) but from this little, brief tidbit, what’s interesting from my point of view is how cryptocurrency and cryptography are starting to crop up in the same breath. And, unlike the 2010s where the interesting tech was about sharing cat pictures, virtually all of the interesting tech I can think of operates in this weird zone of enabling dissenters, since platforms like Twitter and Facebook are essentially tools of the hard-left anti-Trump #resistance establishment now.

As my friend and Israeli secret agent Maya Zehavi observed:

And I added:

What a time to be alive.

Here’s a picture of some marmots, licensed under the Pixabay license.

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Not Legal Advice, 27 October 2019: Long-suffering Bitfinex plays the victim card, The Hinman Test is Dead, and Mr. Zuckerberg goes to Washington

Welcome back to this week’s edition of Not Legal Advice!

Last week I didn’t write Not Legal Advice because I spent the week traveling to see clients and attend the Satoshi Sidetable and Free State Blockchain events hosted by Bruce Fenton and Chainstone Labs in Portsmouth, NH.

The conference was awesome, so thank you Bruce & team for the invitation to speak. Well worth the trip and I highly recommend it next year.

If you don’t know Bruce, you should make a point of getting to know him. Immediately.

Anyway. After a thoroughly high-energy week traipsing around the northeastern U.S. in my truck, I decided to spend my Sunday walking around in the trees and enjoying the crisp New England autumn, rather than sitting behind my computer.

I have no such excuses this week, however, so we are right back to it:

  1. Bitfinex claims it’s a victim
  2. Is the Hinman Test dead?
  3. Mr. Zuckerberg goes to Washington

1. Long-suffering Bitfinex plays the victim card

Poor Bitfinex.

First, in 2017, it gets subpoenaed by the CFTC. Then, in 2018, it’s reported that they’re under investigation by the DOJ. Then, also in 2018, major ringleaders at their (alleged) banker, Crypto Capital Corp (“CCC”), gets indicted by the feds and $800 million of Bitfinex money entrusted to CCC – without so much as a written contract, if the reports are true – gets seized. Then, in 2019, they are placed under investigation by the State of New York. Later in 2019 they got sued for $1.2 Trillion.

Then, this week, the President of CCC is arrested in Poland on money laundering charges… and the Polish prosecutors didn’t have very nice things to say about Bitfinex, apparently. CoinDesk reports:

Polish authorities claim that Molina Lee is wanted in Poland for laundering up to 1.5 billion zloty or about $390 million “from illegal sources,” according to the Polish report.

Authorities wrote that Molina Lee’s crimes included “laundering dirty money for Columbian drug cartels using a cryptocurrency exchange.”

Polish prosecutors claim that Crypto Capital held accounts in Bank Spółdzielczy in the town of Skierniewice and that Molina Lee and Bitfinex laundered illegal proceeds through the country.

Bitfinex didn’t take that allegation lying down, and responded:

In a statement released Friday, Bitfinex said it will “make its position clear” to U.S. and Polish authorities and will continue to pursue the funds that Crypto Capital lost. According to the statement, Crypto Capital had misrepresented its “integrity, banking expertise, robust compliance programme and financial licences” to Bitfinex.

Molina Lee is wanted in Poland for laundering up to 1.5 billion zloty (about $390 million) “from illegal sources,” according to reports in Polish newspaper W Polityce. Bitfinex denied rumors that it had played any part in the payment processor’s money laundering.

“We cannot speak about Crypto Capital’s other clients, but any suggestion that Crypto Capital laundered drug proceeds or any other illicit funds at the behest of Bitfinex or its customers is categorically false,” wrote Bitfinex general counsel Stuart Hoegner.

Poor Bitfinex!

The company is innocent until proven guilty, obviously, as this is America, but I think we can agree that the long-suffering Bitcoin exchange has had a rough ride. Quite the fall from grace for what was once the largest Bitcoin exchange, by volume, in the entire world.

2. Is the Hinman Test dead?

Ethereum is undoubtedly responsible for more legal confusion in the U.S. crypto-markets than any other project of its kind. The confusion began after Division of Corporate Finance Director William Hinman announced his so-called “sufficiently decentralized” test, or “Hinman Test,” in June of 2018, in this policy speech. It goes as follows:

Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value. And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized (emphasis added) networks and systems where regulating the tokens or coins that function on them as securities may not be required. And of course there will continue to be systems that rely on central actors whose efforts are a key to the success of the enterprise. In those cases, application of the securities laws protects the investors who purchase the tokens or coins.

I would like to emphasize that the analysis of whether something is a security is not static and does not strictly inhere to the instrument.

This was followed by pronouncements by SEC Chairman Jay Clayton in early 2019 to that effect. The SEC’s commentary was followed by additional statements in early October by CFTC Chairman Heath Tarbert that Ethereum was in fact a commodity and not a security, but at some later date a code fork could result in the coin becoming a security once again. He said:

“It stands to reason that similar assets should be treated similarly. If the underlying asset, the original digital asset, hasn’t been determined to be a security and is therefore a commodity, most likely the forked asset will be the same. Unless the fork itself raises some securities law issues under that classic Howey Test.”

To wit: Ethereum started its life as a securities offering and then became “sufficiently decentralized” in such a way that it lost its character as a security and became something else, but at some future date due to some future forking activity (*cough* proof of stake *cough*) the system might become a security again.

Mind you, when someone dares to point out that Ethereum should have been treated first and foremost as a security, what invariably happens – every single time – is that a number of legal eagles crawl out of the woodwork to point out that anything is capable of being treated as a commodity, including securities.

This is, of course, legally correct. But it’s not practically correct. Practically, someone re-launching Ethereum from scratch, line for line, with the same marketing, same documentation, and same code, will discover that the resulting product would undoubtedly be treated as a security, as I wrote in my blog post two weeks ago titled “If Ethereum were launched today, it would be a security.” Which I haven’t really heard any practitioner disagree with. Meaning the SEC would and should get involved in regulating the asset before the CFTC has even gotten out of bed.

Where the SEC claims that Ethereum transactions started as securities transactions but are no longer securities transactions, because transmogrification, I find no precedent anywhere in American law that supports the proposition that a security can become a non-security, much less then move back afterwards.

For this reason, I have  arrived, fairly recently, at a theory about the Hinman Test for securities transmogrification. My theory is that, since every system that has attempted to raise the Hinman Test as a defense (Kik and Telegram in particular) has been savagely rebuffed (sued) by the SEC, that the Hinman Test does not in fact exist, it is fiction, and that the most plausible explanation for the absence of enforcement action against Ethereum is that extremely aggressive lobbying by Silicon Valley venture firms convinced the SEC that Ethereum wasn’t a security despite the fact that it is, and it’s too late now for the SEC to turn back. Even though it should.

In a new development, the theory that the Hinman Test does not actually exist has been backed up by statements from the heads of the federal regulatory agencies themselves. Thanks to Nic Carter for asking this very insightful question:

Generally speaking, if a law isn’t written down in statute or isn’t found as a rule in the C.F.R., and there’s no precedent for it anywhere else, it doesn’t exist. SEC v. W.J. Howey, Co., a Supreme Court precedent, is the rule in this instance. That rule doesn’t permit for transmogrification. It asks one question, whether the thing in issue is a

a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits… from the efforts of the promoter or a third party

and if the answer to that question is in the affirmative, it provides no means by which a scheme can somehow turn back over the passage of time, enabled by regulatory forbearance, and erase its prior status because somehow the investment scheme becomes… too successful? Such a conception of the Howey Test defeats the Howey Test’s entire purpose, which is to restrain these schemes and ensure the term “investment contract” in the Securities Act is capable of eternally constituting “a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” Howey, 328 U.S. 293 (1946). The purpose of Howey is to capture those schemes, not to allow them to wriggle away.

In the absence of  legislation from Congress, a contrary rule shouldn’t be adopted by federal regulatory agencies that are generally tasked with enforcing the law, not writing it.

The classification of Ethereum as a “used-to-be-a-security, transmogrified-into-a-commodity, and could one-day-be-a-security-again critter” is absurd. It makes no sense. It does not comport with existing law. It’s a lot of intellectual hoop jumping which could be very easily resolved by simply admitting that the federal regulatory apparatus made a mistake with Ethereum and doesn’t want to burn thousands of Ether investors, including large venture funds, in whose hands these Ether unregistered securities may be found.

Is it time to declare the Hinman Test dead? I think so. Question is, will the SEC correct course on Ethereum, which, due to the bloat and the fact that it is mostly run on nodes managed by one company, and its suspect premine, is likely one of the most centralized cryptocurrencies in existence? Especially since it is likely to only become more so if the promised migration to proof of stake/”Ethereum 2.0″ proceeds?

ADDENDUM, 28 OCTOBER 2019

A colleague points out:

Someone at DC Fintech week noted that in 2013 the SEC released a 21(a) report – like the Report on The DAO – for Eurex Deutschland, which offered security index futures. Security index futures are subject to SEC or CFTC jurisdiction depending on how many securities are in the index. Originally, the underlying was a broad-based securities index (based on various thresholds) – a commodity, subject to CFTC jurisdiction. It registered with CFTC. But over time, the underlying changed to a narrow index (after it crossed one of the thresholds) – which is considered a security, subject to SEC jurisdiction. It did not, however, register with the SEC, which the SEC says was unlawful. Like The DAO, however, the SEC chose not to impose penalties.

I see what you’re saying. Like it’s not a Howey analysis. It’s a mechanical thing – their index went from 5 securities <50% to 5 securities > 50%[,] in line with voluntary SEC/CFTC administrative guidance that created a bright line not present in the case law. That’s very different from a Howey investment contract turning into a non-investment contract by operation of invisible qualitative factors no one can really measure, in a real-world fact pattern, decided by a court.

Basically. And even if we were to look at this from a quantitative standpoint, 72 million Eth were issued in the pre-mine and 108,334,927 Eth are in existence today – meaning that the “security” component of the coin (the premined bit) is still 66% of the overall supply.

3. Mr. Zuckerberg goes to Washington

I’m so sick of hearing about Libra. As I said to Peter McCormack on his podcast:

The thing that really bothered me about the Libra whitepaper was that they think we’re stupid, they think we’re dumb, they think we were born yesterday… but in fact they’re the neophytes, they’re the newbies, they just showed up, and this is our house.

Facebook’s public statements on this project have all been long obfuscation and short substance, so I won’t waste your time with a detailed breakdown – all you need to know is that the company continues to not give straight answers about privacy, data protection, and regulatory treatment that anyone who has operated in cryptoland for more than a year will be familiar with and expect concrete responses to particular questions. Which the members of the House of Representatives were unable to ask, since (with the notable exception of Rep. Warren Davidson) it appears that every other member of the House Financial Services Committee can’t tell the difference between a blockchain and a chimichanga.

The live Q&A added little to the written testimony. Essentially, Zuck showed up in Washington and told the Congressmen that his company is woke af, meets diversity quotas, was there on a charitable mission to bank the unbanked, and if the Congress didn’t get out of his way, that American financial innovation would be leapfrogged by China. As his lieutenant David Marcus tweeted:

What I think Facebook doesn’t understand is that China never deplatformed anyone any American has read or listened to, or moderated any of their social media posts for political reasons. Facebook has.

The American populace doesn’t like it, doesn’t trust it, and isn’t going to be goaded into making it easy for a Swiss-incorporated for-profit “non-profit” to operate on American soil that gives Facebook unlimited access to our financial data whilst allowing Facebook to not actually go through the onerous regulatory process of operating a financial institution.

Buy Bitcoin.

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In 50 years, most schools and universities will not exist

The other day I put up a tweet. It was a deliberately provocative tweet, linking to this article in the Guardian, titled Under digital surveillance: how American schools spy on millions of kids, and I suggested that a better way forward than putting a large portion of the population under 24-hour, state-administered digital surveillance simply because they attend a school would be… well, to abolish the schools. By which I mean replace expensive, capital-intensive, centralized, state-run education with inexpensive, remote, free market, electronic methods, which we should be doing anyway since we have the technology to do it.

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This is, of course, the default libertarian answer to any inefficient state-run bureaucracy. Where the state retreats, someone will build the roads. Someone always does. Immediately my feed was flooded with large numbers of people who ignored the context of the tweet, with prodigious facial hair or “their pronouns,” or both, in their Twitter profiles (protip: 9,999 times out of 10,000, your Christian name or profile picture is a dead giveaway, so listing your pronouns as well is superfluous. Also, third person pronouns are for other people to talk about you, so it’s not going to be relevant if I’m talking to you). e.g. this charming fellow, sounding off with what I suppose they thought were clever replies:

Cool beard, bro.

First, Gab is for free speech and Infowars is, in certain respects, a better news source than CNN, in that it is at least honest about the partisan nature of its coverage, whereas CNN denies partisan bias up and down. Denies it, that is, until a Project Veritas exposé comes along and pulls back the veil on CNN’s own internal partisan bias, following which they admit everything – just kidding! – following which then they continue to deny it. An outlet that openly displays its agenda allows the viewer to know what they’re buying when they tune in. I prefer that kind of honesty.

Second, it’s a great idea. This being Twitter, subtlety was lost in transit when it found its way into the hands of the deliberately obtuse.

Of course it would be absurd to solve a problem relating to schools, if we assume the schools themselves are not problematic, by abolishing the schools. The point, my point, is that the state shouldn’t be in the business of education at all. Proposals to surveil students in real time on all their devices take a bad situation and make it worse. 

Schools that look like factories and have been designed to prepare young people to work in factories, and today are designed to prepare them to work in corporate offices, are not the way they are because the laws of physics demand it.

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They are the way they are because people demand it. Accordingly, we should always remain open to the possibility that radical design changes in the model of delivery could have unintended side-effects and other externalities, negative and positive. We should be looking to abolish state education and replace it with software. If we replace professors with software, many of the political problems the educational system creates – financing, admissions criteria and scarcity, and many more – will disappear. And people will need to find new things to complain about.

Without taking any sides in the gun control discussion – apart from pointing out that I think that much of it is bogus, anecdotal and hype-driven, considering that violent crime in America is at a 25-year low – I generally assume a couple of things when trying to think about policy.

First, in a country where the Fourth Amendment is on the books, I assume that it is bad to condition a generation of Americans to having their civil liberties curtailed and instantaneous intervention from state-funded supervisors. If you disagree with me on this, you are welcome to stop reading this blog post, pack your bags, and move to North Korea.

Second, I also assume that the American system of education produces abysmal results at astronomical costs and it ought to be abolished, although for reasons I will explain shortly, its abolition will hardly be necessary. If you think that the American educational system is the jewel in the crown of our great country and deserves to continue to exist forever as it is currently structured, I would encourage you to look at both the results of the U.S. educational system and the expense incurred in producing those results.

One of the major policy issues going into the 2020 election is the cost of tertiary education. I agree that education is far, far too expensive, and that the vast majority of American graduates obtaining a B.A. on the basis of anything other than in-state tuition at a state university are, for the most part, being horrifically ripped off.

On average, per the National Center for Education Statistics, the cost of tertiary education in the United States has increased fourfold in the last 40 years, inflation-adjusted.

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The same phenomenon is observed if we look at public education as a whole as a percentage of GDP:

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What changed in those 40 years? Did the education get so much better that the princely sum the average college student pays for their freshman year used to buy them all four years? Is a college education now worth nearly $200,000 of debt, accruing interest, which will leave them more or less completely undifferentiated from their peers?

Virtually nothing, except perhaps the existence of vast federal loan subsidy programmes that have permitted the universities themselves to become bloated, top-heavy, and run by increasingly well-paid armies of administrators who busy themselves with regulating every aspect of the university experience, rather than focusing on the teaching. At least that was my impression when I returned to do a year of graduate school in 2017, which stood in stark contrast to my fairly unregulated undergraduate experience in 2002.

A comprehensive exposition of the U.S. educational system is not my forte or chosen area of focus. What I know is that system which produces identical results at greatly increased costs is being run incorrectly.  In the United States, education and healthcare are two such systems.

While the U.S. way of education ought to be abolished, there is no need to abolish it, as market forces will perform that task well enough. Bricks and mortar are expensive ways of handing out credentials.

Let me illustrate this with a story from my personal life. I’m a lawyer. I started out my career in England, and pretty soon after completing my formal education in the UK I explored the possibility of taking the bar exam (2009). Back then, lectures were predominantly delivered 9-to-5 for 12 weeks straight in a lecture hall. Students had to attend the lectures, the professor was available to answer questions, and the bar review course was completed in person.

Fast forward to 2018, when I took (and passed) the bar exam. The course I took (Themis) was delivered entirely over the Internet. The other course (BarBri), which has long been the category leader, was also delivered, predominantly, over the Internet. I knew of not one person – not one – who elected to receive the teaching in person. And why should they? Choosing not to commute for 90 minutes a day just to do rote work in a lecture hall, when one can commute zero minutes and do the same work from home, is an easy choice.

The reason that law teaching everywhere is not already administered online is because of the stigma – backed by law – that is attached, in my profession, to the practice of taking correspondence courses. When I looked to get admitted in America, for example, one of the prerequisites was physical, personal attendance at an ABA-accredited U.S. law school for the 24-credit LL.M. degree – correspondence courses will not do.

This is despite the fact that it is passage of the bar exam, not completion of the LL.M. or J.D., which is ultimately required before anyone can be admitted to the practice of law. It’s possible to become a lawyer without having first attended law school in a handful of states which give a nod to the English system of articled clerkship, such as New York and California, each of which permit bar exam qualification by “reading law” as an apprentice, as Kim Kardashian West is doing. But it is not possible to become a lawyer without passing the bar exam. Passing the bar is the one credential that matters, the one hoop through which every prospective lawyer must jump.

Yet nearly every law student in the United States opts to receive the course that prepares them for this crucial task by correspondence (online) – completing it in their own time, at their own pace, in a way that works for them, rather than on a 9-to-5 schedule where they clock in and clock out. The online course is more convenient, more effective, less expensive – superior.

The educational industry – and it is an industry, not a sacred cow – is not exempt from the perennial gale of creative destruction.

The factories are gone. The assembly lines are being replaced by just-in-time additive manufacturing. The back offices are being replaced by SaaS companies. The modern-day skilled laborer – a developer – is not expected to show up at a fixed place for a fixed duration, but rather is expected to complete tasks in a reasonable timely fashion and, often, remotely.

Education itself is starting to be automated, with companies like Lambda School churning out developers without debt (instead asking for a share of future earnings). I regard Lambda as the most culturally significant startup of the last 20 years. While I have, over the last few days, seen some complaints on Twitter about that program as compared to a graduate of a 4-year CS degree, Lambda’s record of placing graduates cannot be denied – it has proven the concept of debt-free remote education delivery. Getting the quality up (if indeed there is an issue, which I am in no position to assess either way) is not a question of proving the concept. It’s a question of optimization.

We look at factory housing in 19th-century England and see something antiquated. So our grandchildren will look at our universities and schools, conceived as fixed, physical spaces. These expensive, inefficient monuments to our industrial past and post-industrial present will have no home in our digital future, where rather than leaving home to faraway places and distant cities students will be able to learn and build in their own garages and backyards, choosing from a vast array of subjects and courses, online masterclasses from world experts, rather than the limited, commodity “social studies,” “English,” or “art.”

I suspect this mode of living – education that is delivered, not administered, and self-directed, rather than imposed – will grant students more flexibility in choosing what they want to learn, will allow them to specialize earlier, and will allow for more transparent credentialing. What is now spent on administrators, buildings, security, and mass surveillance could be redirected to academic contests and prizes or project grants for community development.

Expensive methods of teaching that produce poor results should be abolished. Institutional inertia prevents this from happening. Fortunately, abolition by law will not be necessary, as technology and market forces will do the dirty work as surely as natural processes erode the mountains into plains. The only questions are how much of a fight educational institutions will put up to stay relevant as they get outflanked by software, and how long their resistance will last. In the fullness of time, the scalable qualities of computer-delivered education will eradicate bricks and mortar schools and universities, just as Amazon eradicates retail, additive manufacturing eradicates long global supply lines, cryptocurrency eradicates central banks, and photovoltaics eradicate coal fired power stations.

Digitization and decentralization are our future, and nothing will escape.

 

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