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- [00:00]
A
So I would say AI is not just slightly scarier. I would put it, I would put it on the level of like the nuclear bomb because it has civilizational implications. And to me, every time, every time I listen to like Jesse's like beautiful explanations and analysis of all this stuff, all I think about is like, this is, and maybe this sounds like very anti capitalist of me, but I really do think that like AI is different than all of those things that you just named kk, right. Like, it really is something that I think should not just be left to the private sector. There should be some sort of, I've said this before, but like some sort of public private collaboration, right? Like similar to what we did with the Manhattan Project and other sorts of efforts. Like historically, like, I just think AI is just totally on a different level, that we can't just leave it to private, the, the private sector and decide like whether we want to trust them or not. I mean, the answer to that is no. They're a business. We can never fully trust them. Right. And so to me, it's just different.
- [01:03]
B
Hi all and welcome to Dex in the city where the wallets are cold and the takes are hot. Before we get going, as always, remember, we're lawyers, but we're not your lawyers. And nothing you hear on decks in the City is legal or financial advice. And it doesn't create an attorney client relationship. For the fine print, check unchained crypto.com we have such a good episode for you. But before we get started, here's a word from our sponsors.
- [01:26]
C
Fidelity has been investing in blockchain since 2014. They're not wondering if digital assets will shape the future. They're hiring the talent to help ensure they do. Explore opportunities today@crypto.fidelitycareers.com Fidelity is an equal opportunity employer. This episode is brought to you by Cape, America's privacy first mobile carrier. Same premium service you'd expect from any other carrier, but designed so your number, your location and your data actually stay yours. Get 33% off. Six months at Cape Co Unchained.
- [02:06]
B
And we're back. First we have Jesse Web3 prosecutor turn Web3 protector at Ribbit Capital and V from the SEC to Web3. And I'm your host, Katherine KK fluent in Tradfi and conversant in deep tech over at starkware. So this was one of those weeks, frankly, where we always discuss what are we going to talk about? And some weeks were kind of like, there's a lot of news but nothing more worth discussing. This week I think we had like 15 potential topics and none of them seemed absolutely massive. Like, not a massive hack or a huge, huge new law, but all of them were significant in their own right. But possibly the most juicy of the topics we discussed and the craziest topic that we discussed was so appropriate for this podcast and our resident AI expert, Jesse. So, Jesse, take it away. Tell us about this anthropic drama and all of the stuff that is going on in AI this week.
- [03:05]
D
Finally, my time to shine, letting me go first with my AI update. So, essentially what happened this week is the federal government bricked an AI model, and this happened on Friday afternoon, but the saga has continued into even this morning. So in case you missed it, which I'm sure you didn't, if you watch any news, the government forced anthropic to take Fable 5 and Mythos 5, which are related models, offline globally. And to me, that's not even the most staggering part, because although this started as a cyber risk story, it turned into an export control story and then in my mind, a KYC story, which I'll get to know your customer, which we've talked about, and then devolved into this crazy personality clash between the admin and a company that may have committed the cardinal sin of having, like, the wrong political vibes or at least the wrong messaging or messenger. And to me, this is all like, not just fun and games for crypto who can, like, watch from the sideline, because we need to be thinking about the implications as an industry. This is not just an AI story. It's a censorship story, or at least a choke point story. And we know lots about choke points. I think V talked a long time a few episodes ago about operation choke point 2.0. And it's relevant to bring that context into this because what happened there in many ways is happening to AI and model access. And so we shouldn't just be sitting here being like, crap, I loved Fable. I can't access anymore. We should be worrying if the government can use a secret process to shut down a frontier AI model without transparency, notice and comment. Any real insight, then we all should be a little bit worried. So with that grounding context, I just want to break down a little bit of what happened for those who weren't paying attention every single second, who maybe have a life on the weekends. So anthropic releases Fable, Fable 5, and it's a more secure version of Bithos, which we talked about, the sort of crazy, scary cybersecurity struggling model. And I don't know If y' all were able to try it in the few days it was out. But it was cool. And it showed an improvement in the model, but nothing like, too scary. But regardless, just a few days later after it was released, it was disabled on Friday because the admin said you need to disable it, essentially. But we'll get into the details there. Why? Well, we're still figuring out why, and there are facts and there are rumors, and I'm going to try and separate them here, but they're a little bit intermixed. So according to some reporting, Amazon, which is an investor in Anthropic but also a big competitor trying to get ahead in AI, raised concerns with the White House that Fables guardrails could be bypassed. Now, Anthropic and many cybersecurity experts are saying the government and Amazon don't know what they're talking about. They're not understanding the bypass. This exists in other models. And so this is a very technical argument. I won't go too deep, but there is a real, true argument about whether this bypass is real or not or whether anyone understands it. And we don't really know because the government has not been transparent.
- [06:20]
B
And Josie, really quick, before you go on, can you explain more about why it would be so bad if someone could bypass this? Like, I understand this, but I want you to illustrate this to our listeners because I don't think people really grasp how serious all of this is.
- [06:36]
D
Yeah. So we talked about Mythos in detail on a different episode. Mythos is the model that Anthropic said, this is too scary. We're not going to release it. Instead, we're going to give it to a glass wing group of companies and let them make sure that their systems are ready for this. The reason why people were so afraid of Mythos is the potential, like, cybersecurity risks of it. So if, like, Mythos was enabled for everybody, including, like, illicit actors, they might be able to hack into a bank is sort of like one of the big concerns that was out there or really everything government or the federal government and the huge repository of sort of happening anyway. Yeah, yes. The, like, financial institutions were prioritized here as well as the government getting access to it. Now, Anthropic spent time trying to build a more secure version of Mythos. And how that worked is they put in all these restrictions. So if you asked Fable about building a medical wep, like a biomedical weapon or building some sort of toxin to expose to the world, they would say, fuck no. We were not answering that even though we're an AI and there was like no good way to get around that. And in fact they made it so extreme that if you asked anything about like chemical compounds, they would say no. So like some people were complaining that like for their kind of work, Fable wasn't viable. Now what has maybe happened, but this is pure speculation, is that Amazon or some other entity was able to get past the question of, let me ask you about this chemical compound. But if you do that with any of the models, you could potentially get information. So anthropics, like you're not understanding this. And something that's interesting to note here and once again, we don't have all the details but all the narrative of this story from the White House and admin and the actors involved commenting on it publicly are not technical folks and there is no evidence that they brought in national security experts or technical folks into the conversation. Plus, because other models that are open sourced outside the United States that like maybe hackers do have access to already have like these bypasses enabled, we are potentially cutting our knees out, you know, by, you know, making it a lot harder to enable cyber security here. So that would be how I would answer that. Any questions or you want me to keep going?
- [09:10]
B
Oh, and keep going. All of this is giving me Enemy of the State vibes. Does anyone remember that Will Smith movie? It's a really good movie.
- [09:17]
D
Is it so good though?
- [09:19]
B
It. What?
- [09:20]
D
Is it still good or was it just like.
- [09:22]
B
That's a great. I need to re watch. But I feel like we talk about iRobot all the time. Another, you know, kind of dystopian Will Smith movie. But we. How have we not talked about Enemy of the State, which is about data and surveillance and. Please continue.
- [09:35]
D
Yes, no, totally. Okay, so government says you got to shut this thing down, essentially. But what they actually said is that foreign nationals, not just people outside the United States, but foreign nationals, cannot access Fable 5. And that includes foreign nationals that work for Anthropic. And obviously Anthropic employees are not all US citizens. So essentially Anthropic said, well, we got to cut it off for everybody because Anthropic. And no AI system has kyc, but maybe they do now, right? Because maybe this all is just the administration inventing KYC for AI and for all of tech. And I just want us to sit with that for a second because crypto and the industry has spent a decade plus fighting against rules that didn't make sense. I'm not saying all of them don't make sense. But the ones that don't make sense, that you should have to show an ID or a passport to open a wallet because this limits financial access and freedom. But now the government is putting AI and KYC AML rules in some ways into an expansion mode where it's touching not just financial services, but maybe AI or maybe other tech. And how should we be thinking about that? And maybe we're just going in the wrong direction now on certain things when it comes to KYC without a discernible process. And I may sound biased here, but the truth is anthropic is not perfect. These frontier models are scary. But to me it's like, is it
- [11:09]
B
too much to ask for a process
- [11:10]
D
that's transparent, fair, clear and grounded in technical facts, but where we're just crying for more kyc? And I'm going to like give a hot take here. This reminds me a little bit of the Gensler area because then the complaint was like, no clear rules, shifting standards. You find out where you cross the line after the shutdown order arrives, you get a subpoena, and now we're taking that and layer on scary ass, amazing transformative technology, and then claims a political bias and censorship, although that might be part of it. But it's unclear if that's true because there's bipartisan pushback on this. So it is time for crypto to be taking a stand here because this is not just anthropic, this is not just AI. This is terrifying for all tech and builders because if the government has real evidence of national security threat, like show it, create a process, build a rule, instead, right now we're like living in this muddy space where we don't even know what happens. And there's conversations that fable's going to come back, but we won't even really know why this all happened at the end of the day. And right this weekend it was anthropic, but next weekend it could be something totally different that affects our industry or affects tech in ways that we don't really want.
- [12:29]
A
So is the government claiming that they can't say why for, like national security reasons?
- [12:34]
D
No. Right.
- [12:35]
A
Which is what they do sometimes. Right?
- [12:37]
D
They're not really. But as many people who follow this current administration are aware, the narratives are a little bit all over the place because they're saying it has nothing to do with political bias. Nothing has to do with anthropics like Department of War issue that we talked about or Department of Defense. Both of those names still exist from a month or two ago. But then Pete Hegseth tweeted out or put out a statement saying, this is what happens when you don't cooperate with our war efforts. And then David Sacks put out a statement that we talked about as well that blames Anthropic. And then there's this odd narrative that they couldn't actually get in touch with Dario to stop all of this or make it, like, easier to resolve because he was at a wellness retreat. But there's no evidence of that. And, in fact, he wasn't supposedly.
- [13:29]
B
Dario, the CEO of Anthropic.
- [13:30]
D
Yes. So it's turned into this, like, crazy the boys are fighting kind of framework. And there. The fact that none of us know what's going on. And also, I think there's going to be a reason, like a very high potential that we'll never know what happened. Yeah. So there's nothing to learn here except, like, oh, my fucking God, what are innovators in the United States supposed to do? Because this is certainly not helping AI stay on shore.
- [13:58]
B
A couple points here that I wanted to make. One, it's very interesting that this is going to be one of Jay Clayton's first focus areas. The point when he is confirmed as Director of National Intelligence. And for those who weren't aware, this was another interesting news item. So Jay Clayton was former chair of the SEC from, I believe, 2017 to 2020, and then he was interim United States Attorney for the Southern District of New York, which is basically the headquarters of all of the, you know, all of the prosecutions surrounding major financial crime in the United States. Now he has been nominated, and all signs point to a very quick confirmation process for Director of National Intelligence. So very interesting kind of financial background that he's going to bring to this environment as you're talking.
- [14:45]
A
Noteworthy is he's. So the SDNY is the office under him that is continuing to pursue, like the Tornado cash case. Oh, yeah.
- [14:54]
B
Which is frustrating. And I have my thoughts about sdny. I mean, it attracts the. The creme de la creme of lawyers, for sure. It also attracts highly ambitious lawyers, like a lot of people that just want to run for office, go and. And, you know, try to work for the sdny, although there's also extremely, extremely talented prosecutors, brilliant legal minds, but weird dynamics there, given the. The focus. But the other. The other thing that occurred to me, Jesse, as you were talking, is we've talked historically about how crypto and AI are like weird cousins, and most of the time, it's crypto wanting to, you know, be friends with AI and all of that. But it does seem like cryptography offers a slew of potential technologies that could help at least mitigate some of the theoretical issues here. I mean zero knowledge proof technology springs to mind as an obvious choice in terms of data protection or additional security with respect to a lot of this surveillance. And I hope the two worlds are talking to each other enough to explore like the best practices going forward here. And I'm a little afraid that they aren't necessarily.
- [16:12]
D
They are not. They are not as far as I know. But what I will say is part of the problem. Not to put it all in crypto, like AI industry isn't talking to each other. Like Anthropic and OpenAI have a very non secretive frenemies to enemies story. Right. And I don't. I as you all know, have really appreciated Anthropic's warnings about its technology and asks for regulation. Which reminds me a lot of like the good actors in crypto too at the time.
- [16:46]
B
Yep.
- [16:46]
D
But it's a very difficult line that they're trying to walk as well saying like this stuff's scary. Regulate us. But also let me find a way to put out the best model which we told you is based on, let's say Fable is super safe. Let's just assume that. Right. They the narrative that led them to release Fable is Mythos is the scariest thing we've ever seen. But don't worry, trust me, trust us. So it just comes back to like, who are we supposed to trust here right now? I feel like until this whole debacle there were a lot of things about Anthropic I wanted to say, like I trust them. I feel like they left OpenAI with the goal of creating a safer product for everybody. But they're also saying this stuff's freaking crazy. So that's where it's like, I think as a user day to day with AI, we don't stepping aside from the crypto industry, like we don't really know what all this means. And so saying I think kk, I agree with you. Like there are a lot of things about cryptography that could. But the truth is, is like we don't really know enough about how this tech works because it's not transparent. Which gets us back to like maybe AI and crypto have lessons to learn from each other.
- [18:04]
B
It's the chicken and the egg to a certain degree. And you also made a really good point. It's like since the beginning of time, consumers have struggled with who to trust. And you could talk about this in any context. Food, furniture, cars, like we could go on and on and on. I feel that way so intensely as a parent. Like I'm like, what can I feed my children that isn't going to give them cancer? Like, you know, so I mean it's, it's in every industry that consumer trusts and I, I'd say AI is slightly scarier because you have highly sophisticated individuals that still don't understand even or don't have the ability to get the information they need to make the appropriate assessment.
- [18:48]
A
Okay? So I would say AI is not just slightly scarier. I would put it, I would put it on the level of like the nuclear bomb because it has civilizational implications. And to me, every time, every time I listen to like Jesse's like beautiful explanations and analysis of all this stuff, all I think about is like this is, and maybe this sounds like very anti capitalist of me, but I really do think that like AI is different than all of those things that you just named kk, right. Like it really is something that I think should not just be left to the private sector. There should be some sort of, I've said this before, but like some sort of public, private collaboration, right? Like similar to what we did with the Manhattan Project and other sorts of efforts. Like historically, like I just think AI is just totally on a different level, that we can't just leave it to private, the private sector and decide like whether we want to trust them or not. I mean the answer to that is no. They're a business, we can never fully trust them. Right. And so to me it's just different.
- [19:52]
D
I agree and I think that's why the international efforts here are particularly important as well. The problem, you know, from the innovator's perspective, which I think like crypto can be empathetic towards, is the federal government sort of can't make up its mind. You know, we've talked about the fracture. So on one side they're like stopping something because it's super dangerous. But remember the EO that they were supposed to pass and then they minimized it and made it smaller and now they're saying the stake states shouldn't be able to regulate at all because it's going to hurt our ability to compete with China. So now I feel like everyone is sort of just watching this chaos ensue and no one really knows what's going on. And I think hopefully in 20 years we'll have some sort of like real insight here. But anthropic isn't talking to the Government. The government, they're just speaking different languages and the problem is like the consumer is speaking a third language.
- [20:50]
B
Yeah. Perfectly put. And for what it's worth, V, I don't think that's anti, anti capitalist of you. Like, I'm an ardent capitalist and was trying to explain the dangers of socialism to my 8 year old the other day and my husband was making fun of me. And I think what you're, you're pointing out an obvious risk that has nothing to do with the economics of the situation. This is all completely unchartered water too. So a little scary. But speaking of capitalism, guys, we need to talk about something different because I'm getting depressed by this conversation. So moving on. There to be a dystopian element to like every single one of our episodes.
- [21:33]
D
Yeah.
- [21:35]
B
Whether it's like dinosaurs or you know, AI, I love it. I, I have a love hate relationship with it. But we have a different piece of actually pretty big news that was one of our kind of obvious topics and it feels more and more these days. It's so funny. It feels like every week we have some sort of CFTC topic. And we've said this before and I'm going to say it again. It's so interesting that for years the CFTC kind of languished like at your average big law firm. When I was growing up as an associate, you probably had 50 expert SEC practitioners. You might have had one CFTC expert. It was just kind of the stepchild of financial regulators in that people just didn't focus on this regulator in the way that they focused on the sec. That feels like it's really changed and it's changing by the day. And it's not necessarily due to crypto, it's due to a number of things. One of them being prediction markets. Okay. And perps. But we're not going to talk about that on this episode. So, fairly big news. The CFTC released a notice of Proposed Rulemaking. And this process, this means they propose a rule and they publish that rule and they request any comments before the rule is finalized. So like speak now or forever hold your peace. This Notice of Proposed rulemaking on prediction markets is almost 300 pages. I have finally worked my way through all of it and Everybody only has 45 days to comment after it's published in the registrar. So. So get cracking if you want to comment. This actually follows an advanced Notice of Proposed Rulemaking on this that they published in March. So first they said, hey guys, we're going to issue a notice of Proposed rulemaking on this. So get your comments in. They got something like 3,500 comments and despite all of those comments, they managed to issue this giant notice in the 40 odd days after the comment period closed. So they reviewed thousands of comments and wrote almost 300 pages. It's actually incredibly impressive how productive the CFTC is being with not a full staff, frankly. Maybe that's, that's one of the reasons for the productivity with the missing commissioners. We still only have one chair, we need commissioners. But I just will go Rules by the way makes it a lot easier to be productive when there's only one chair.
- [24:04]
D
Okay.
- [24:05]
B
But probably the most important change in this, I obviously I'm not going to go over the 300 pages but there's a couple really impactful things. For anyone who's been following prediction markets, anyone who's been following the litigation, the overwhelming litigation, they are proposing an Amendment to Rule 4011 which has really been the center of a lot of the litigation. This is the rule that where the language prohibited event contracts involving gaming. Actually the, the full language was terrorism, assassination, war gaming or an activity that is unlawful under any state or federal law. It actually seeks to change that and it changes it by saying the CFTC may in fact make a public interest determination that the contracts are violative. And then it also creates a highly structured review framework for any contracts that may violate public interest. And then it also seeks to define some really relevant terms that everybody's been fighting about like gaming and involvement. I think this is actually super impactful. Oh the other really important point is it completely clears the path for political election event contracts which I actually love that part of that because I've long been a proponent of political event contracts. There's a, you know, hundreds of years of history of in the United States of people betting on political events. It's not against the public interest. It's actually incredible for transparency but for sporting, for gaming, this is, this is really big. And the other interesting thing is all these contracts can trade while under review. And if the commission doesn't trigger a public interest review, the contracts are home clear. And even if they trigger a public interest review, the contracts can trade while the CFTC is reviewing these contracts. So my take on this outcome is, is look like stuff like betting on injuries in sports not going to be okay. Like that's going to fail the public interest test. But this new definition of gaming encompasses sports in, in a way that makes stuff like final scores totally okay to be under the sphere of prediction markets because that doesn't fail the public interest. So I think I love the transparency. It's still going to completely piss off the state gaming authorities, like the state gaming commissions. Like it's not going to end any type of litigation on the federal state front. It's a step forward on clarity, it's a step forward on transparency. So I support this. But I am interested in both of your takes because I know definitely V and a little bit, Jesse, disagree with me on my, you know, necessarily even want to call it pro prediction market stance, but my intellectual belief that the CFTC is right in exercising its federal authority over these contracts. Yeah.
- [27:04]
A
So first of all, I want to thank KK for her service of combing through these 300 pages for our listeners. So I hope you guys are grateful. So, I mean, I'm not going to say what like my general position on prediction markets is. Again, I feel like I've talked about, about that a lot on this pod. I, I agree with you that like the most important thing is that it's helping to draw lines, right, between what's okay and what's not. And I think that's really, really important because I think even the platforms have been struggling for a while to themselves determine like what kinds of contracts are okay or not. And same, same with like the users, right? Like the users also don't know like what's okay to spin up, what's okay to bet on or place predictions on or not. So that I think that's really important. And it seems like what they've proposed is principled. Right. And I think the important thing too with these kinds of rules is like, is it actually workable? Like, are the platforms, are users actually going to be able to take this and like apply it to specific situations? Is it going to be easy to enforce? Right. So I think it, I mean based on what you're describing, I think it does sound workable. But again, like I, you know, one of the beautiful things about how like the agencies work and I think this is like just a beautiful thing about like our system of democracy in general is that we do have this like public notice and comment period. And I'm going to talk about this when we get to the reg NMS stuff too. But like, people really do need to weigh in on this because there's so many different stakeholders. I think there's a lot of reasonable perspectives on all sides of this debate. So like, I really, really encourage people to, to get involved in that process
- [28:48]
B
and to weigh in and themes emerge when through the public comment period which is very interesting. If you analyze these comments across the wide spectrum, you can definitely see market wide themes and regulators really do review these comment letters, guys. So like, and by the way, for our listeners, you don't have to be a GC or even a lawyer to submit a public comment. In fact, that should not prevent you from weighing in as long as you are a market participant that has an opinion that might be affected by these changes. They really do want to hear from a wide spectrum of market participants.
- [29:25]
D
I agree with everything y' all are saying and there is a lot of good here and it does make me hopeful in that I think the concept or the statement of public interest as I am putting quotes around it sort of means nothing because it means very different things for different people. Like I think even on this pod between the three of us, we might have slightly different ideas of what that means for prediction markets. So I really do appreciate that. And on the point of like how amazed I am that they got this out, I agree. Like we have talked at length about how many people have been either fired or left the CFTC and how it's a small agency as is compared to the sec. So the fact that we were able to do this is really admirable. Admirable. But I think at the same time there's a flip side of that coin, right? Like how do we feel about one commissioner being able to push this stuff through? Like how do we think about that as a democracy as someone that does believe in both private sector capitalism balance with our US democracy, Like how do we think about that? And at the same time of that, like even if you're okay with that, because we do have the notice and comment period so much about this rule also puts it on industry to self police. Right? Because you do this self certification if you don't have people working at the CFTC to look at these once they've been self certified, are we creating a different mess that only needs to be cleaned up when something bad happens to consumers? So that is like where my balance is here because I really like the productivity of defining these really vague terms that are vague because that's how legislative process, process happens. But on the other side, like if we're going to define it, we have to make sure that we can enforce it. And that's the question mark for me
- [31:23]
A
I think like you're actually required by law to review every single comment. I mean I assume they're using AI
- [31:30]
D
to help with this, which I hope
- [31:33]
A
so, you know, which is how they were able to, like, get the rule out in the amount of time they did, given the. The volume of comments they received. But I don't know.
- [31:41]
B
We need to get someone from the commission on this pod. We can ask them about AI usage. It's actually, it's actually a great question. The other point that I'll make that's really interesting is the Commodities Exchange act actually specific. The one chair scenario was unprecedented until this happened. But. But it specifically provides that a vacancy should not impair the right of the remaining commissioners to exercise all the powers of the commission. So it. It basically gives him the right to do whatever he wants and needs to do. In direct contrast to the sec, I believe in V. Call me out if I'm wrong on this, but I believe they have a quorum requirement where a codified quorum requirement generally requiring something like three members for official action. So that's actually a big difference. Like, the SEC can't do certain things without at least three commissioners. The SEC can do whatever it wants.
- [32:38]
A
Yeah, I think that's right. But it. The three commissioners don't have to be from, like, both parties. So, like, you know, if I think. I mean, I don't know the actual stats on this, but I think with rules that are adopted or even proposed, like, it does tend to fall along political lines anyway. So maybe, like, it doesn't really matter in practice, but. But yeah, I mean, I agree with Jesse that a full quorum or a full slate of commissioners is, is better in part because, like, you know, even if the commissioners vote along party lines and ultimately adopt a rule, a lot of times the minority commissioners will put out dissents that are actually really thought provoking and like, contribute to the debate. And I think that is very valuable. And it's like a real loss to investors and the public that we're not getting that.
- [33:24]
D
So, yeah, I also think, like, on the point of even if Republicans are going to win this anyway or whatever, like, we want not just the US of the world to be bought into this rule, into prediction markets. We want the entire citizenry of the United States or the ones who are even remotely interested to have faith in the process, because that's the whole point of all these, like, ridiculous government bureaucracy processes.
- [33:50]
B
It's one more mechanism to help future proof a lot of what's happening, frankly, because I agree that it adds credibility. About a month ago, there was a couple people in the AG Committee that encouraged, you know, President Trump to fill these open seats. But it's still, you know, this is unfortunately just not a priority. So I hope we I hope we see them soon. So we are going to go to break and hear from our sponsors and when we come back we'll have more sexy financial regulatory conversation from V. So stay tuned.
- [34:22]
C
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- [36:00]
B
And we're back. So we have discussed scary AI, we have discussed CFTC. Obviously it's time to discuss the SEC and actually something fairly significant that happened last week. So V, please tell us more.
- [36:16]
A
Okay guys, I, I still like don't have a voice. I think it's between the Bad Bunny concert I went to recently and this like epic just like Nick's run and like final spin that we just all witnessed. So bear with me. I'll do my best. Okay, so I want to talk about my second favorite topic after vaults of course, which is reg nms. Right. So as you guys know, I worked as a lawyer in the SEC's enforcement division for many years, including on cases involving best execution, which is the duty that says that brokers have to obtain the most favorable terms for their customers orders. Right. So it's not actually an SEC rule, it's a FINRA requirement, but it's closely related to Reg. NMS. So the big news is that last week the SEC said they want to repeal two important parts of Reg. NMS Rules 611 and 610E. And just to give people a sense of what a big deal this is, these rules have been in place for two decades and are a big part of how our stock market is structured. So at a very high level, the rules organize the stock market around something called the nbbo, which is the best publicly displayed price to buy or sell a stock, a stock across all the major exchanges in the U.S. right. So what it's designed to do is just basically help all of the different exchanges function more like one, like single interconnected market so that customers are getting the best price for their orders. So Rule 611 says you generally cannot give someone a worse price if a better price is available somewhere else. And then 610e tries to prevent situations where you have a willing buyer and a willing seller and they're showing compatible prices, but because they're on different exchanges, those bids are never actually matched. So I wanted to talk about like why this, why I think this is relevant for crypto and this is my theory and, and why I think this move is actually really huge for helping to clear the way for on chain securities markets. Right. So obviously these rules were written for traditional exchanges, you know, which have things like order books and displayed bids and offers and brokers routing orders around. But you know, that's not how crypto markets work. Right. An AMM like Uniswap doesn't look at every other exchange before it trades. It just prices against a liquidity pool and then it executes automatically. So you could force an AMM to plug into all the old market data and routing infrastructure, but then you're basically just rebuilding the old system just on a blockchain. Right. Which is not exactly the goal here. So I think what repealing these rules could do is remove a real barrier to tokenized equities trading, potentially allowing an AMM to execute according to its own liquidity pool and allowing things like solvers and aggregators to compete to find and correct and correct price differences across different venues. And that it also, you know, raises interesting possibilities about like what role on chain oracles and other crypto native kinds of systems could play in this new market structure. So basically just a more crypto native way of Achieving something like best execution. So obviously, you know, this doesn't mean that like Apple stock can start trading on Uniswap tomorrow. I think there's some still a lot of legal questions that remain. But I do think it flips the traditional framing of, you know, how do we make crypto fit into the traditional market structure and the existing rules to how can traditional market structure actually adapt to accommodate crypto systems? Right. So I'm going to take a page from KK's book and mention a paper I wrote earlier, earlier this year, Fairness by Design, Verifiable Execution in On Chain Markets. And the basic point of that paper is that best execution is actually much more complicated than just giving your customer the best display price. Right. Like customers could. Customers and institutions could also care about things like speed or privacy or certainty of fill or market impact. Right. Or information leakage, all of these other factors that could play into best execution. So in traditional markets, brokers usually make these trade offs and decisions internally and behind the scenes. Right? So like the customer can't see how they made the decision and where it gets routed in real time. And then the regulators will come in later and try to figure out whether the broker actually gave the customer the best outcome. Right. I mean, like I said, I worked on best execution cases at the SEC and it was notoriously hard to reconstruct what happened after the fact and whether the customer really did get best ducks. So my paper argues that crypto offers a different model. Right. And it's not to say that on chain markets don't have plenty of execution and conflicted order routing problems of their own. Right. Like we all know about harmful forms of mev, but what's interesting about crypto markets is they've actually created a lot of interesting tools to address those problems through market design. Right? So you have things like solver auctions where multiple parties compete to give a user the best outcome. And you have private transaction channels that can reduce front running, programmable sequencing rules, and even things like cryptographic attestations that can show both investors and regulators in real time how a transaction was actually handled. These are things that are not possible in traditional securities markets. I think the point is because these rules would have been difficult, if not impossible for crypto markets to comply with, removing them helps clear the way for more crypto native securities markets to actually come into being. So anyway, I spent many years thinking about traditional market structure and how crypto is a natural evolution of that. So to me this is really, it's just such an exciting and interesting topic even though it's so nerdy. But I said earlier I really encourage the industry and, and anyone who has like interest in this to submit comment on this. It's a 60 day comment period. I'm planning to submit something so that the rules actually get replaced with a market structure that really is better for investors and not just like lead to more intermediation and opacity just on a blockchain. Right. I really want people to see this as this is a chance for us to build better markets using technology that is now available to us. So that's why I think the rescission of the rules is really exciting.
- [43:09]
D
It's also such a great reminder for all of us that sometimes rules that have the best of intentions, which here it seemed like even though it's an older rule, that it was made to protect consumers that actually have created unintended consequences that maybe hurt the consumers in the long run. It's also interesting that I think Atkins dissented from this what, 20ish years ago and is coming back to fix it now, which is sort of a beautiful like full cycle, you know, vision of this. But to me it's like whenever it seems like the right thing to do to protect consumers with X ruled, just pause and think about what the unintended consequences could be. And that also requires you looking at frameworks of, you know, capitalism, bad actors, how that all works and what actually will happen to consumers if this rule is put into place.
- [44:02]
B
That's, that's exactly the point I was going to make. Jesse. When I was reading up on this, I stumbled upon the same thing. Like people might forget that Atkins was a commissioner in 2005 when REG NMS was adopted, when you know, the SEC consolidated market rules to kind of acknowledge that the fragmented technology required that unified regulatory response. And he said, like he and one other commissioner basically said, look like this should be solved by competitive forces rather than unnecessary regulation. Which is also in line with his position as, you know, a Republican commissioner. Less regulation, more hands off government. And we've come full circle. Like I, I imagine that to some degree he's kind of satisfied with the evolution of this here. And isn't that the beauty of crypto, that it solves problems like it solves problems that may or may not need to be addressed by regulation. Now, you know, lawyers and some people tend to immediately move towards the position of we need to regulate this. This is new, we need to regulate this. And it's interesting, sometimes you have to step back and look at technology that says, well, maybe this technology removes the need for regulation in the first place. Not always, but I think that is certainly an important piece of all of this to consider.
- [45:25]
A
Yeah, I think, I think the danger here is to, like, rescind these rules. Right. And just assume that competition will take care of everything. Like now, you know, competition will mean that brokers and exchanges can't screw their customers anymore. I mean, I don't totally have faith in that, which is why I hope that that's not the outcome here. And I. And why I want. I want crypto market participants to weigh in, especially projects that aren't just leaving it to market forces to make sure that investors are protected. And you still have fairness and accountability. Right. Like, I think crypto offers a lot of really interesting. Crypto and decentralized systems offer a lot of really interesting solutions that can help to achieve investor protection and market integrity, just not through regulation. Right. Through actual really smart system design. And I think that's really important. Right. We don't want these rules to be rescinded and customers to be left unprotected. The opportunity here is to actually use this technology to build the protection in. Through. Totally.
- [46:29]
B
I don't think any of us are ascribed to the yolo. The YOLO mentality of there's no laws when you're drinking claws. Like, no, we don't need to go there here. Anyway, so we have one more brief topic before we move to some really fun crypto good news. And it's a shorter topic, but we felt like we needed to at least address it because there's been so much press surrounding this. And what is it? Okay, it is the tokenized share conversation. And it's funny, what we're talking about is last week the Wall Street Journal published an article that said. I believe it was. I don't have the article in front of me, but Citi rolling out tokenized shares. And I double check, and that article actually still has that headline, which is very interesting because they're not tokenized shares. And if you Google this now, you'll notice all the other headlines, including Citi's press release themselves. Yep, it's on the screen now. Yeah, the Wall Street Journal headline says, citigroup is rolling out tokenized shares of private companies. But when you look at the news now, and you look at cities, Citi's own release, it actually doesn't say tokenized shares, it says tokenized depository receipts. Because these are not actual shares of companies, they're receipts. They're tokenized depository Receipts. And I just noticed even during this podcast, podcast news broke that Coinbase is joining the tokenized stock race with onchain shares and dividend payments. So they said that investors will own the shares and receive dividends. And this is just one more sign that we're going to continue to see this rush to tokenize securities, which raises a lot of legal questions. My big issue with tokenization right now is that I think tokenization has moved so fast that there has been no time for the legal infrastructure vis a vis tokenization to catch up. But you're also going to see this impact kind of the broader spot market and raise a lot of questions. The other thing that I'll note is the hope here, some people were like, why is this a big deal? The hope is that it increases liquidity. And this is always the conundrum when you're talking trading, when you're talking products. I'm sure anyone who's worked for any crypto company, it's like, we have this great idea. The next problem to solve is liquidity. Okay, so if this increases liquidity in the markets, particularly for institutions and endowments and family offices, all accredited investors, which makes it easier to navigate the securities laws around this, what is this going to do to do to the broader ecosystem, especially all of these players, and I don't want to call them intermediaries because it's crypto, but all of these players and partners that plug into the tokenized security ecosystem. So this is definitely a topic I'm kind of watching with bated breath.
- [49:32]
D
Yeah, I think we should definitely follow up on this topic. But the short answer is like, the tokenization aspect is easy. It's figuring out how it works with all the plumbing and making sure transfer agent works, etc. All works underneath it and that the issuer is bought in. Which is the most interesting fact for me from the city announcement that the issuers involved here, because as you saw with some of the debacles of X stocks and getting space, IP, SpaceX, IPO, the issuer was not bought in, in what they had promised their customers. So there's going to be an interesting balance here of like how much of the control is to the issuer.
- [50:10]
B
Yeah. So watch this space. We'll have more on tokenization. And that brings.
- [50:16]
A
All right, I think this is what the innovation exemption is supposed to address.
- [50:20]
B
Right.
- [50:20]
A
The one that got put on pause because it like there was all this controversy around what it was going to say. Anyway, we'll keep you guys posted when that happens.
- [50:28]
B
Still waiting on that innovation exemption. Yeah, you're absolutely right. All the rumors point to the fact that the innovation exemption was supposed to address tokenized securities. Tokenized shares. We're still waiting on that. Obviously, there's a lot of uncertainty as to the breadth and depth of that innovation exemption too, because, like, that's a big piece of this. You know, what aspect of tokenized shares or securities are they going to cover? If I know this sec, I have a lot of faith in this commission and in Chair Atkins. Even after Commissioner Purse leaves, I think that they'll do this hopefully surgically and strategically.
- [51:09]
A
But.
- [51:11]
B
Okay, so that brings us to our last segment of the day, which is also related to tokenization. This is crypto good news. We're actually not 100% sure this is good news, but, Jesse, please explain and please use props.
- [51:26]
D
This has been a meaty episode, so I thought I'd bring in a little mascot for this next one. This is a brachiosaurus that I have had. It's one of my many dinosaur collectibles. But essentially the good news, but also maybe not great news, who knows, is the announcement of something called Jurassic Finance. Now, I can't say that this isn't a scam. I'm not telling anyone here.
- [51:51]
B
We do not endorse this. Okay?
- [51:53]
D
I have no idea about anything about it, but it combined two of my loves, which is blockchain and dinosaurs. So essentially what Jurassic Finance is doing is. Is it's tokenizing dinosaur bones and fossils. I don't know if I can even say it without laughing, but it's allowing for the on chain ownership of what they call Earth's rarest asset. So unclear how this is going to happen, but essentially the people who are getting your money if you invest in this are going to source dinosaur bones and fossils from different locations. I have a whole array of ideas. And then once they're able to get it, you will own a piece of it and it will be loaned to different museums. So you're giving back to the community as well? I guess. I don't know. I am going to keep an eye on this because if it gives me the opportunity to own some dinosaurs, I will be a part of it. But also, I will also be looking out for the scam level of it. But it's a cool website.
- [52:51]
B
An unnamed friend in response to this wrote, omg, this looks like a black market for dinosaur boat. So, I mean, that may or may not be.
- [52:59]
D
Oh my God. Did you see what the tokens called?
- [53:03]
B
Rawr. And I'm done.
- [53:06]
D
I'M buying it.
- [53:06]
B
Now, on that note, I mean, you could just be like Nicolas Cage and spend all your money buying literal dinosaur bones, like. But I also don't recommend that. That's not financial advice. But don't recommend that as an investment. Like. Okay, so on that note, you know, cheers to summer and dinosaurs and the Knicks, I guess. And we'll see you next week on Decks in the City. Sam.