The Back of the Envelope (a blog)

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.


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.


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?


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.


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.

Screen Shot 2019-10-26 at 4.10.45 PM.png

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.

Screen Shot 2019-10-26 at 1.55.48 PM.png

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.

Screen Shot 2019-10-26 at 1.38.07 PM.pngScreen Shot 2019-10-26 at 1.37.52 PM.png

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


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.



Not Legal Advice, 10/13/19 – Ethereum has a good week; Facebook has a bad week; Bitfinex has a worse week; Telegram has a terrible, horrible, no good, very bad week

Welcome back to Not Legal Advice, my weekly crypto and crypto-adjacent technology law newsletter-blog-series-thing! Subscribe via e-mail, WordPress, or RSS at the bottom of my homepage.

This week:

  1. SEC, CFTC and FinCEN remind everyone that money laundering is bad.
  2. Ethereum has a good week.
  3. Facebook has a bad week (Libra on the ropes, with withdrawals by Mastercard, Visa, eBay and Stripe adding to last week’s departure of PayPal).
  4. Bitfinex has a worse week (getting sued for $1.2 Trillion (with a T)).
  5. Telegram has a terrible, horrible, no good, very bad week (gets sued by the SEC in federal court).

1) SEC, CFTC and FinCEN remind everyone that money laundering with cryptocurrency is bad

Read their joint statement here.

I doubt that Jay Clayton, Heath Tarbert and Kenneth Blanco (head honchos of the SEC, CFTC, and FinCEN, respectively) would issue a statement just because they were hanging out drinking beer one afternoon and said, “hey, you know what would be cool? An announcement. That’s nearly as fun as interagency softball.”

What seems more likely is that this statement is framing a narrative that will be relevant for future enforcement. Keep your eyes open for what comes next.

2) Ethereum has a good week

The CFTC’s comments that Ethereum is to be treated as a commodity seemingly confirm that, despite robust securities enforcement by the SEC against Telegram, Eos, Sia, Paragon, and dozens of other projects, Ethereum is getting a free pass.

Read my write up where I argue that if Ethereum were launched today, it would be a security.

3) Facebook has a bad week (Libra on the ropes, with withdrawals by Mastercard, Visa, eBay and Stripe adding to last week’s departure of PayPal)

This was inevitable. As I wrote back when Libra broke cover in July:

If Facebook raised an army, this would be only slightly more hostile to the people of the United States than what is currently proposed. Big Tech doesn’t share American values and doesn’t care about American users. It doesn’t care about the unbanked. It cares about money. It cares about building defensive moats, i.e., monopolies. And Libra – the tech industry monopolization of global finance – is a phenomenal way to get both free money (the token represents, after all, an interest-free loan from Libra’s users) and a very deep, wide moat, not just for Facebook, but also for every other major category leader/tech monopolist on the planet.

After tumultuous Congressional hearings, regulatory pressure from the Europeans, the straw that appears to have broken the camel’s back was a letter from two U.S. Senators, Sherrod Brown (D-OH) and Brian Schatz (D-HI), to a number of payments infrastructure companies advising them that teaming up with Facebook would not be in their interests.

Sen. Brown of course has been a vocal opponent of Facebook’s forays into crypto from the start:

Here’s an excerpt from the 1.25-page letter the two senators sent to the CEOs of Mastercard, Visa, and Stripe. Salient passages include:

Facebook is currently struggling to tackle massive issues, such as privacy violations, disinformation, election interference, discrimination and fraud, and it has not demonstrated an ability to bring those failures under control. You should be concerned that any weaknesses in Facebook’s risk management systems will become weaknesses in your systems…

Your companies should be extremely cautious about moving ahead with a project that will foreseeably fuel the growth in global criminal activity.

Yikes. In other words, “Facebook is sailing into some rough seas. You sure you want to get into bed with that?”

The letter then concluded:

Facebook appears to want the benefits of engaging in financial activities without the responsibility of being regulated as a financial services company. Facebook is attempting to accomplish that objective by shifting the risks and the need to design new compliance regimes on to regulated members of the Libra Association like your companies. If you take this on, you can expect a high level of scrutiny from regulators not only on Libra-related payment activities, but on all payment activities.

This is government-ese for “check yourself before you wreck yourself.”

Visa, Mastercard, and Stripe promptly withdrew from the consortium on the 10th of October, as did eBay, joining PayPal, which withdrew the previous week.

Although as your correspondent put it on October 4th:

4) Bitfinex has a worse week (gets sued for more than $1 Trillion).

Bitfinex has been sued for $1.2 trillion (that’s “trillion” with a T) dollars in a lawsuit that alleges the company engineered the multibillion dollar 2017-18 cryptocurrency bubble and crash by printing fake Tether dollars. Read my write up.

5) Telegram has a terrible, horrible, no good, very bad week (gets sued by the SEC in federal court).

(With apologies to Judith Viorst.)

Telegram is a popular encrypted messaging app, not just among crypto-nerds, but among people everywhere. It is used by well north of 300 million DAUs (daily active users) who

  • are looking to encrypt their communications and think they’re too cool for WhatsApp, but
  • don’t know that they should be using Signal or Keybase.

In late 2017/early 2018, as Telegram blew past the 200 million DAU mark, the company decided to raise money in an ICO, or initial coin offering. The offering raised an astounding $1.7 billion (with a B) for a pre-product, pre-revenue blockchain system known as the “Telegram Open Network,” to have the ticker symbol “TON,” with tokens known as “Grams.”

Silicon Valley’s most storied investment firms practically fell over themselves to participate.

LOL, rekt. From the Financial Times

The hiccup: in the TON investment documents, Telegram promised to launch the network by 31 October 2019 or, failing which, Telegram investors would have the option to recoup their investment, less expenses.

Telegram was, understandably, in a hurry to get the network live and the tokens issued before the end of this month (as it is, as of this writing, the 12th of October). Unfortunately for Telegram, on October 11th, the Securities and Exchange Commission filed an emergency action and obtained a temporary restraining order against Telegram preventing them from doing so, all but assuring that the company will fail to meet the deadline – and ensuring protracted litigation will interfere with the launch of the network for some time to come.

The structure of the offering was that (a) Telegram would pre-sell $1.7 billion of Grams to investors under Regulation D and S exemptions to registration (b) Telegram would retain $billions of dollars worth of Grams for itself and (c) after launching the network, those investors and Telegram itself would flood the U.S. markets with tokens.

The issue with this is that (a) apparently Telegram didn’t adhere to the strict requirements of Regulation D during the sale, (b) the SEC considered that not only the investment agreements to purchase Grams but also the Gram tokens themselves would constitute investment contracts, and (c) that Telegram was making efforts to sell, and planned to sell, these tokens direct into the U.S. markets through U.S. platforms e.g. Coinbase Pro et al.

And apparently Telegram then refused to accept service of a subpoena the SEC served on it overseas.

So the SEC sued Telegram and slapped it with a temporary restraining order ordering Telegram to appear in the New York federal district court on October 24th to explain itself.

Points to note? Despite what the SEC paints as a pretty open-and-shut case, Telegram’s counsel is Skadden, Arps, which is a little strange seeing as – to the extent Skadden advised on the original deal, as reported in the New York Times – one would think a firm as expensive as Skadden might have seen this coming or, at the very least, wouldn’t have advised Telegram to evade service of a subpoena. It’s of course impossible to know what was said behind closed doors, but now that I and others are starting to look at the Telegram sale more closely that’s one of the first questions that crossed my mind.

Equally, Skadden may be expected to mount a robust defense now that its client has been sued.

Furthermore, this paints the US as a thoroughly hostile environment for ICOs, despite the SEC’s repeated insistence on not enforcing against Ethereum in the past or the recent 60 basis point slap on the wrist given to the $4 billion Eos ICO. The overwhelming theme of the recent SEC enforcement, including Telegram, means that the best move for an ICO issuer not using the Regulation A+ issuance pathway trailblazed by Blockstack may be to avoid the United States entirely.

Obviously your mileage may vary and this column is called Not Legal Advice for a reason, but if there’s a takeaway point from this it’s to expect ICO activity in the U.S. to diminish going forward rather than increase.

This also calls into question the exchanges’ listing decisions to date, noting that the so-called Crypto Ratings Council classified both Eos and Grams as not being securities. Meaning that their ratings of anything that isn’t Bitcoin or Ethereum are, so far, 0-2.

And expect more enforcement.

And with that out of the way, time for your weekly Moment of Marmot:

Land shark

If Ethereum were launched today, it would be a security

We learn today that the CFTC Chairman has declared Ethereum to be a commodity.

I think this view, understanding the word “commodity” in the plain and ordinary meaning of the term rather than as something which is capable of being the subject of a futures contract, is not correct. An Ether token has less in common with a soybean than it does with a share.

And before you chime in with the comment “durrr a security can be a commodity too,” from a signaling standpoint, if the CFTC is making this statement in public, it likely means is that the CFTC and the SEC have finally and irreversibly concluded their discussions in private as to how primary regulatory responsibility for Ether is to be apportioned between them, a discussion which is rumored to have been going on behind closed doors for years.

The market has accordingly taken the statement to mean that the CFTC will be taking point on regulating markets for the product and that the SEC is out of the game. This is the final stake through the heart for those Bitcoiners who had hoped Ethereum would be deemed a security and thus wiped from existence on U.S. exchanges.

Although this has undoubtedly cheered the folks at DevCon, as it should, I would struggle to advise a client that launching an Eth clone tomorrow – let’s call it Dogethereum – would be an advisable course of action.

wow such contracts

Anything that I know of which has been created by a private company, by book-entry, and pre-sold to the public accompanied by offering documents, as an investable asset, has been, and should be treated as, an investment contract. Sales of these beasties should either be registered or subject to an exemption to the registration requirement. Numerous other products – Paragon, Airfox, Eos, Sia Veritaseum, and others – that are remarkably similar to Ethereum have been regulated and regarded as a security by the Securities and Exchange Commission. That’s both the initial offering and, in some cases, the resulting token (as in e.g. Paragon, where the SEC ordered Paragon to file a registration statement with respect to its tokens). Ripple Labs is being sued in a class action that claims it is selling securities. There are many other such cases.

Yet Ethereum is different.

There’s no magic, legally binding pixie dust here.  Regulators simply looked the other way. On several occasions. This may be because there was a different sheriff in town (Mary Jo White) when the Ethereum scheme first launched, or that the statute of limitations ran in August. Or because marmots from outer space secretly control the US government and decided to let this one scheme slide. Nobody knows. In any event, I am not sure why this scheme is different from all the others.

Legally speaking, I don’t think it is different. I think it’s just dumb luck. Simply because nobody from the government has endeavored to explain their regulatory forbearance doesn’t mean my position isn’t correct.

Ethereum is an experiment that cannot be safely replicated

To understand how

  • Ethereum isn’t, legally speaking, any different from any other two-bit ICO, and
  • how the “sufficiently decentralized,” or so-called “Hinman Test” (which has no basis in law) is not something to be relied upon,

We should ask ourselves one question:

“What would happen if we replayed the Ethereum ICO, exactly as it happened in 2014, today?”

Folks looking to sell Ethereum-like products today should not presume they are purely in commodity land. To do that would be a mistake and would run contrary to all we’ve seen from the SEC, in terms of both express guidance and what we can learn by implication from the regulatory treatment schemes that aren’t Ethereum have received.

Namely, that if you’re selling tokens for fun and profit without a no-action letter, you’re selling securities, and you should expect your activities to be within the SEC’s regulatory perimeter.

Revisiting Dogethereum, a hypothetical token sale that is in all material respects identical to Ethereum (hell, you could even fork the Ethereum codebase and offering documents, which are on GitHub, and try this out, although this would not be advisable), I am fairly sure that if you attempted to run that exercise tomorrow, with offering docs, marketing, etc., in the United States, you’d be selling an investment contract and the SEC would concur with this view.

I dare anyone to explain to me why such a scheme would not be an offering of investment contracts and what makes it different from Jay Clayton’s stance that “every ICO I’ve seen in a security.” 

I do not apologize for taking this view. I never will. Legal advisors have to be realistic when their clients ask them why it was OK for Ethereum to do something but not OK for the client to do it.

The reality is that selling unregistered investment contracts without registering or availing oneself of an exemption is against the law. If you want a lawyer who will tell you to “take a chance, we’ll try to make money and if it goes pear-shaped you can pay me to fix it,” good for you. You can hire someone else.

My answer is this: Ethereum’s different “because reasons,” not because of the law. The law is basically what the SEC has applied in its day-to-day enforcement activities since September 2018, and what is referred to in the settlements it concludes. Howey, the Securities Act of 1933, etc.

What crypto-bros like Coin Center would prefer the law to say on the subject of Ethereum is drawn from a throwaway line in a brief policy speech setting out the so-called “sufficiently decentralized,” or Hinman, Test upon which Ethereum supposedly relied. That “test” states, in brief:

[There are circumstances in relation to which] a digital asset transaction may no longer represent a security offering. If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.

This test should have been taken, at the time, with a pinch of salt.

First, what does “decentralization” even mean? Nobody agrees on the meaning of that term.

Second, and most significantly, it was made by Director Hinman in a personal capacity rather than on behalf of the Commission, so it never became official policy. It certainly wasn’t binding precedent.

Third, there appears to be no precedent provided whatsoever – either in that speech or since – for the proposition that something which starts its life as an investment contract can somehow lose that quality over time, any more than a share or a bond can somehow degrade with age. But that’s the tack Director Hinman took, which led him to conclude, in the same speech,

…putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether,

i.e. the ICO was a securities offering,

the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.

My question is this: how?

How does the SEC know for a fact that material information asymmetries receded, when the crowdsale itself was unsupervised (and most Ether thought to be held in very few hands)? How is Ethereum “decentralized” when most of its full nodes are run on AWS by one company and a full node can’t be run on consumer hardware? How is there not an issuer or promoter when there is a Swiss Stiftung literally named the “Ethereum Foundation” that organized the offering, is endowed with tens if not hundreds of millions of dollars of Ether generated in the offering, manages the meetups and web presences, holds all the IP and controls the GitHub repos, or large enterprises helmed by Ethereum founders that exercise outsize influence on the ecosystem? Don’t you think it might be possible, nay, even prudent, to get disclosures from people and companies like that?

The Hinman Test describes a hypothetical scenario where we can say with certainty that a cryptocurrency scheme has become natural, unmanipulated, and fair, where all market participants have the same information. It is unlikely this is the case with any cryptocurrency, including Ethereum.

Maybe folks figured this out as, in the 18-odd months since that test was first laid down, we’ve never seen the Hinman Test used again by the Commission in any context. The only time we’ve seen it is in that one speech where it explains that one decision. The idea of “true decentralization” does not exist in the Commission’s official guidance and the one time the concept of “decentralization” is mentioned, it is not defined. Although the idea that a security may be re-evaluated at a later date and found to have transmogrified into a non-security is in the guidance, this would not save Ethereum if we re-launched it from scratch tomorrow, and can be best understood as speaking to the commission’s thought process, and not as an expression of a rule of law.

I know of no legal precedent that supports the proposition that securities can transmogrify into non-securities, especially under circumstances where the security becomes more popular among the investing public and the purpose of the original unlawful scheme is fulfilled, and none is cited by the guidance.


The Hinman Test has not found its way into settlements with any coin issuers. It has never been raised successfully as a defense. The one company that publicly dared to raise it, Kik, was promptly sued shortly afterwards.

Screen Shot 2019-10-10 at 7.36.17 PM.png
Screen Shot 2019-10-11 at 9.59.31 AM.png

Apart from that one speech and that one decision, it appears that the “Hinman Test” doesn’t exist. Which means that if we were to re-run the Ethereum crowdsale from scratch today, Ethereum would be treated no differently than Paragon Coin.

Why is Ethereum the special case? Why did it escape scrutiny while Kik, and virtually every other coin offering the SEC has settled with or sued to date, has not? Maybe Ethereum got too big. Maybe the harm to investors and crypto businesses that would arise from deeming it an investment contract would have been too great. The only reasons I can divine that Ethereum is treated differently are that the scheme was enormous – hundreds of billions of dollars made and lost – and multiple major venture capital firms with a ton of exposure lobbied for this one unregistered, non-exempt coin offering to be treated in a particular way that sets it apart from every other unregistered, non-exempt coin offering ever conducted.

And they succeeded, because money talks. But you, startup entrepreneur, do not have that kind of money or access. So if you try the same thing, you are unlikely to succeed.

Concluding: as with the Eos settlement, this Ethereum revelation is not a green light to start selling tokens in the US with reckless abandon. It is an aberration, an outlier, a special case.

You can still get in trouble, and if you try to re-run the Ethereum presale line for line, even if you use the same marketing materials, make the same representations and use the same code, you probably will.

Be guided accordingly.