From the legal confusion surrounding blockchain in the US to the myriad of opportunities and challenges blockchain poses for law professionals – we leave no stone unturned in our conversation with attorney Gabriel Shapiro – who left big-tech corporate law practice to craft innovative legal strategies for clients developing blockchain technologies at new tech-focused firm DLx Law.
- The US has a very fragmented regulatory system for blockchain technology, which is why many people are excluding the country from their blockchain projects.
- The biggest burden in the US is that almost every token that’s economically interesting is going to run a high risk of falling under the securities regime. And because the securities laws are probably the most burdensome of them all, that makes a huge difference.
- That there is nothing in terms of end-user experience and a functional result that blockchain can accomplish, that can’t be accomplished, technologically speaking, more efficiently, more quickly, and with better user experience, by traditional client-server architecture. What blockchain can do better is provide a trust-minimized environment. One of the big obstacles to blockchain adoption is that this trust minimization has to be part of the value system, it’s getting people to have that value system.
- Blockchain regulations need a deep policy discussion, working groups need to get together and spend time trying to design a comprehensive framework.
- For many traditional Silicon Valley tech companies, 2018-19 has been the year awakening to blockchain technology and thinking about lucrative and potentially cool ways to use it.
- With blockchain, it’s the first time when lawyers need to start becoming technologists and technologists need to start becoming lawyers.
- One of the areas where tokenization can be massively helpful is where the existing markets are already decentralized, but very inefficiently decentralized – a great example of that is US public equity markets.
- Digitization is always beneficial, and blockchain is a form of digitization, so it’s easy to say that blockchain provides these benefits, but a lot of times it’s really the digitization that is doing it.
- “If you put the thing on the blockchain, does that lead to more individual asset sovereignty for people?” – this is the best metric for deciding whether blockchain is the optimal solution.
How did you first get involved with blockchain?
I first got involved in blockchain in 2015. I remember in 2014 reading Zero Hedge with a junior associate in my office very late at night on a deal and making jokes about how we should spend our bonuses on this new thing called bitcoin. Of course, neither of us did. If either of us had, we would be doing great right now! But what really kicked it off for me was what I read about Ethereum and hearing the word smart contract. Once I read a little bit about them, since I was a deal lawyer and a corporate lawyer and spent most of my time drafting contracts, I just intuitively felt I understood it and knew it could be huge. That was when I got super-interested, and from then on, I just got more and more engaged with the space. I started mining a little Ether on my gaming computer. I started attending meetups about the DAO Hack, one thing led to another, and I started working it into my legal career.
I’ve read some of what you wrote about the legal aspects of blockchain and it’s really fascinating. So let’s talk about those regulations. In your opinion what are the key features of a regulatory regime for blockchain and cryptoassets?
I’m going to talk from the US perspective because that’s what I know best. In the US we have a very fragmented regulatory system. We have a commodities regulator, we have a securities regulator, we have the money regulator, we have a tax regulator, we have consumer regulators, and we have those both at the federal level and in every single one of the 50 states. That’s a whole lot, and for a lot of those, there’s no real reconciliation between them. For example, there’s no federal money transmitter regime where you must comply with one set of rules and you’re good; you have to comply with all 50 states, do audits for all of them, so it’s really burdensome.
There has to be a recognition that it’s just not going to work for this technology, you will kill this technology if you simultaneously make it the worst thing it can be for tax, the worst thing it can be for money transmission, the worst thing it can be for security, the worst thing it can be for commodities and subject it to the maximum to those five or six different regimes. That’s just going to be a huge regulatory tax on the technology and it will not work.
So, to me, that’s the recognition that this thing falls into too many buckets at once. It needs a new streamlined process that borrows the most relevant and important aspects from each of those and fits it into some sort of unified slot. Right now, that is not the approach that’s being taken at all in the United States, it’s just simultaneously regulated as all the different things and let the chips fall where they may. I think that’s why a lot of people are excluding the US from their blockchain projects, and complaining a lot, and having a lot of confusion and pain when it comes to US law for blockchain.
Have you noticed other jurisdictions around the world where it’s done right?
Well, I’m not the greatest student of other legal systems, but I think the biggest difference is that in many of the European nations, and also in Asia, they have what I’ll call a civil law style approach, particularly in regard to securities. A security is an enumerated group of things – it’s stock, it’s bonds, it’s certain types of warrants for example, so it’s more specific. In the United States, we have this robust common law tradition, as well as a very, very powerful regulatory administrative law layered on top of that where regulators have massive amounts of power and discretion and the tests are much vaguer.
So the biggest burden here is that almost every token that’s economically interesting is going to run a high risk of falling under the securities regime, and in the civil law jurisdictions because they have this enumerated approach. Most of them don’t currently fall under the securities definition in those regimes, and because the securities laws are probably the most burdensome of them all, that makes a huge difference right off the bat.
Let’s talk about blockchain adoption. All of us in the community gets really excited whenever blockchain is adopted anywhere and there is lots of adoption happening all around the world. What are, according to you, the biggest obstacles, legally speaking, to wider adoption of blockchain?
From a legal point of view, it’s having clarity around the regulations. But here’s the thing about blockchain – I believe that there is nothing, in terms of end-user experience and a functional results, that blockchain can accomplish that can’t be accomplished, technologically speaking, more efficiently, more quickly, and with better user experience, by what I’ll call traditional client-server architecture.
If you think about paying money, PayPal does a really good job of that, it’s fast and it even has fraud guarantees added. If you think about playing a game like CryptoKitties, you could play way heavier games, at way faster frames per second, if you let Steam host your game and just play through that. You name it, non-blockchain technology can do it. But what blockchain can do, that these other things can’t, is do those things in a social trust-minimized environment. Where I may not know who I’m playing the game with, so to speak, and there may not be a trusted third party who’s monitoring it, providing guarantees against fraud and providing performance guarantees; but because of the way the peer-to-peer architecture, and the consensus mechanisms, and the crypto economic incentive mechanisms are set up, I can do this without feeling like I’m going to get ripped off. So that’s what you get with the blockchain piece.
The cost is that it’s slower, and at least currently has worse UX, and it’s more complicated and so on. So, one of the big obstacles to implementation is that, since it’s not really a value-neutral technology, this trust minimization has to be part of your value system, is getting people to have that value system. Because if you don’t have that value system there’s really not a lot of need for you to use blockchain. I think a lot of these black swan events, like the Cyprus Confiscation, like the stuff that’s going on in Venezuela, maybe some of what we’re seeing going on with Facebook and Twitter and the social media censorship – if you get a critical mass of those, and people get sufficiently angry about the results of trusting third parties, then I think you’ll have this more widespread basis to use blockchain as opposed to the alternatives.
So, that’s like a zeitgeist blockage to implementation on top of whatever regulatory blockages may exist. When there’s a critical mass towards something, that’s when the regulations might change. Or, frankly, the blockchain developers are getting so clever they can make the law virtually unenforceable when it comes to these things – that’s an alternative path to putting pressure on the law to use carrots instead of sticks.
I agree with you on this vision of blockchain and I think anybody who has tried to explain how blockchain works has to come to this conclusion. It’s not faster, it’s not cheaper, it’s not more convenient – yet it has this almost psychological aspect that makes it such a revolution.
That’s right. I call that individual asset sovereignty. You have to value individual assets sovereignty in order for blockchain to seem like an incrementally good thing to you.
There’s this gap between regulatory certainty and encouraging innovation – this is always the dilemma that lawmakers have with new technologies. Is there a way to bridge this gap? What are the major issues to consider when trying to find a balance between them?
There are different approaches that are being tried and I have a certain bias in regards to them. One approach is what we’ve just seen with the Token Taxonomy Act that’s being introduced in Congress -a new version of it was just released. That approach is to say: ‘Look, the current regulations are just killing blockchain, it’s very confusing and we need to fix it, because blockchain is good and we need to find a path forward. So, here’s what we’re going to do – every law that’s blocking blockchain, let’s just define what blockchain is and then just say it’s not subject to that law.’
That’s basically what the Token Taxonomy Act is, it defines digital tokens, and you could question the merits of how it defines them, but it says that the Securities Act of 1933 is hereby amended, that definition of securities in there, just say at the end “except this doesn’t include tokens”. That’s literally is what it is, that’s one approach, and I think that’s been the most common one where blockchain champions come in – often in some way sponsored or subsidized by blockchain companies that have a desire to lighten the regulations – and this is their approach. To me that is just so intellectually bankrupt, it’s just as bad as if it were an oil company coming in and saying ‘Oh, all the environmental rules, just at the end, this doesn’t apply to oil companies.’ That’s just crazy, right? No one is going to get behind that.
The right way to do it? Blockchain can be used in lots of ways; blockchains can be owned by a private company; they can be permission-based; they can be public; they can be used to trade securities; they can be used to trade commodities; they can be used to trade video game collectibles; they can be used to store data; all kinds of things. As a society, what are the things about this blockchain that we think is so positive and so good that we should be incentivizing people to create them? And should we, in a balanced way, be relaxing some of the rules around it?
Because if certain rules are so strong that if they apply they’ll just kill the whole thing – then which are those and what is the best way to dial them back a little without just creating chaos? To me, that’s a policy discussion. You don’t go in and just start drafting stuff, you have a deep policy discussion, you get working groups together, you get lawyers, you get other economists, other types of people, and you spend maybe two years trying to design a comprehensive framework – then I think we’ll get something good. I’m more a fan of that approach. There has been very, very little of that approach and a whole lot of the first approach.
What do you think it is going to be like in a couple of years from now, especially talking about blockchain adoption in the real world?
I should probably mention one other approach – go to the regulators, which do have a lot of discretion in the US, and just say ‘hey, work with us, work with the existing law, develop some new interpretations around it, get some no-action letters and sort of carve out a space in which this can happen.’ So, they’re the three approaches.
I don’t think the first approach, where normal laws just don’t apply to blockchain because blockchain is cool, is going to get anywhere. I think all those things will fail. I think that the incremental regulatory approach probably has the most likelihood of getting something from it, incrementally that’ll be happening, and it will open up a little bit more space for the technology to work in.
The larger project, I really couldn’t say. The person in me who wants to see that type of approach thrive says, ‘Yeah, I’m going to beat the drum and I’m going to make that happen’. But the realist in me says ‘man, it’s really hard to create a brand new regulatory framework’. So, on a two-year horizon, I’m not super bullish that we’ll pull that off but I would certainly like to try it.
You work as an attorney in Silicon Valley, so I wanted to ask you, what is the opinion of the big tech companies about blockchain? Especially considering that the hype of the last couple of years associated ICO is behind us?
I was a very mainstream, big-law attorney doing mergers and acquisitions, and transactions on the buy-side for tech companies, so I feel like I have a good sense for them. Even in 2017, blockchain was barely on their radar at all, except as a curiosity. What I think has happened, is that for a lot of traditional Silicon Valley tech companies, 2018-19 has been the year of them waking up to this technology and thinking about, certainly lucrative, and potentially cool, ways to use it.
Facebook, from the rumors that I’ve heard, and from some of the news stories, not from any privilege, I don’t work with them anymore, but they supposedly are building a huge blockchain team. They’ve acquired a company to help them do it and I’ve heard crazy numbers like they have 50 people, but I don’t know if it’s true. But certainly, for them to put that level of investment in it, they must see a lot there. Now, will it really be what you would think of as “true blockchain”, or will it be a kind of credit system that is called a token, but ultimately, just depends on Facebook’s servers? I don’t know. But clearly, they see that this is their way of getting into the payment space.
They probably are looking at WeChat in China which is an integrated payment and social media “all-in” experience. I’ve got to believe that Facebook is going for that type of thing and that they think blockchain is their route to that. I’ve also seen some privately-held Silicon Valley tech companies that are responding to problems caused by Facebook and Twitter, with the censorship and the data leaks, and saying ‘maybe blockchain can solve this?’
Honestly, I think this is the best use of blockchain, in social trust minimization. They’ve been selling people’s data, that’s a good thing to do and there probably are people who want to sell their data, but they need to have control over it. They need to be able to turn the spigot off, as you’ve seen with the Brave browser, and there are some similar models brewing from other tech companies – they need to get paid for it, not only have us getting paid for it.
I think there’s a big move away from this idea that you get free software and you’re the product that is sold on that free software, back to a more… I won’t say it’s gone as strong as a notion of user ownership, at least not from traditional tech companies… but that you have rights on the platform, that you’re going to be protected and you’re going to be rewarded. I think blockchain is becoming the vehicle for traditional tech to get into that mentality.
Let’s take a look at this whole thing from a lawyer’s perspective – there seems to be a lot of attention on blockchain and cryptoassets from lawyers. Recently, Forbes reported that an Australian whitepaper titled “Blockchain for Lawyers” had 1.7 million views – so apparently people are interested. Do you think that blockchain and cryptoassets will become a standalone practice for law professionals?
That’s the multimillion-dollar question, right? I left my cushy big-law gig, which I did enjoy although it had some flaws – I would probably be very close to making partner right now if I had stayed. But I left to join a blockchain company in-house, just to learn, and now I belong to a firm called DLx – a six-person boutique, doing virtually “all blockchain, all the time”. So, of course, we think about and discuss this all the time – is this a viable business model? Is there enough market demand for it? My sense is yes. I was talking about this to a more senior lawyer who’s been in the industry a long time, and he was saying ‘I’ve been working on technology transactions for many years. I just always thought of the technology as just a widget, just a black box, I don’t need to understand it, it’s going to be sold, it’s going to be licensed, whatever, who cares?’ It didn’t make a lot of difference.
I think that blockchain technology, for the first time, can’t be thought of as a widget in order for warriors to do their job. For example, take something like a smart contract, the whole point of a smart contract is that it should be performing aspects of a business arrangement basically automatically, and if you were to ignore the details around that, you wouldn’t be able to draft a natural language contract that goes along with it, or to advise your clients about whether it’s binding. Because you don’t understand how it works, you don’t understand which things it’s doing, which things it’s not doing, and so on. So, this is the first time that lawyers need to start becoming technologists and technologists need to start becoming lawyers.
Yes, it’s cool to work on blockchain and to dive into the tech but there’s a bigger trend going on where law and technology are going to fuse. You see that even in the law firm models themselves. There is a law firm called Atrium, it was founded by the guy who founded Twitch and some other startups that were very successful, it has a VC-backed technology arm, and then a law firm, and they have a little bit of an incestuous relationship where the tech is dog food into the law firm, and the law firm’s clients, and there’s probably some money changing hands as well. I would imagine that’s just going to become bigger and bigger and bigger. So blockchain is a great vehicle for us to explore that, while also crafting unique expertise. I’m learning to code, sitting on GitHub, reviewing my client’s code very carefully as part of advising them. It’s just fantastic, I do think it’s filling a niche, and the niche will grow into becoming mainstream probably within 10 years’ time.
Talking about learning new things, let’s jump into the tokenization of assets. Can you explain what the tokenization of assets is?
I wrote a paper on corporate stock tokenization because a lot of people were talking about tokenization of assets, which I think is great, I think it’s very cool. One of them was Anthony “Pomp” Pompliano, whom a lot of people know on Twitter, and he famously said that the whole world will be tokenized. As a lawyer, you’re thinking ‘what does that even mean? What does it mean to tokenize something?’. At the end of the day, it’s a form of representing an ownership interest, that may exist on the social and legal layer, in the real world. So, we already kind of have that, right? We have pieces of paper that are a title to land, or a piece of paper that’s a stock certificate that represents title to the stock of a corporation and you can sign that over and sell it for money to someone. So really what you’re talking about is just digitizing those instruments and putting them on a blockchain.
Now, when you just describe it like that, it doesn’t sound that great, and I don’t think it necessarily is always that great. But, one of the areas I think it actually can be massively helpful, is where the existing markets are already decentralized but very inefficiently decentralized. A great example of that is the US public equity markets, where purely by virtue of the fact that back in the old days it was really inconvenient to run across town to hand someone a paper stock certificate, a system was developed where there’s just one trusted authority, and its affiliate called DTCC, that holds all the stock certificates for all the public companies. They then issue what you could see as fractional interest in these big stock certificates to brokers and then the broker issues them down to their clients. It’s a very decentralized system with different fragmented ledgers that often get out of whack and cause problems because they’re inconsistent. Well, damn, now, now you’re talking, right?! If you could go back to the original reason why all that happened, which was that it was impossible to trade stock certificates at scale, guess what? If you tokenize the stock certificate, now it’s possible to trade stocks, certificates at scale, right? And you don’t need all these intermediaries and these different conflicting ledgers.
So, with something like that, tokenization of real-world assets, or traditional assets, can make huge sense. Another area where maybe it makes sense would be with land titles because they’re so old fashioned, but to me, that’s just digitization. Obviously, there are massive benefits to be had from digitizing land records, from digitizing UCC filing statements, in a way that’s more accessible to the public. Is blockchain really the best method of digitizing? That I don’t know. But, when you get things that are trading a lot in the system is already decentralized, like stock for public corporations, then absolutely, blockchain is the right answer.
This is the impression I got from your paper. You are sort of telling your readers, who are so excited about blockchain and tokenization, to slow down – it’s not that amazing as some people tell you. But you still advocate implementation in some areas, especially when you talk about this concept of increased individual asset sovereignty. Can you elaborate?
Again, digitization is always beneficial, right? Blockchain is a form of digitization, so it’s easy to say that blockchain provides these benefits, but a lot of times, it’s really the digitization that is doing it. So, why would you use a blockchain method of digitizing? My personal metric for that, which I mostly get from reading the original cypherpunks is asking ‘if you put the thing on the blockchain, does that lead to more individual asset sovereignty for people? As compared to a hosted solution?’
Right now, people have very low asset sovereignty – personal direct property rights – in their stock of publicly held corporations. If I were to buy a stock of Apple, I don’t have a relationship with Apple, Apple doesn’t know who I am. So, how could Apple have a more direct relationship with me? Again, it would be by getting rid of these intermediaries, and blockchain is great for that. On the other hand, take a private venture-backed company, take SpaceX for example, it has some big-time investors and it probably doesn’t have a really big stockholder base. Now with that, because the securities are private, they’re very illiquid, they can’t read very much due to the securities laws, and there, blockchain doesn’t necessarily do a whole lot, because there already is a very direct relationship between SpaceX and its investors. Space X doesn’t want its securities trading more, because then it would have to deal with more people, and they might be a pain, they might sue Elon Musk for breach of fiduciary duty when he does crazy stuff. So, it’s really about finding the right places, where this technology truly has net benefits, as opposed to net costs.
Finally, do you think that tokenization is the ultimate solution towards increasing liquidity of certain assets?
No. Why would it increase liquidity? Liquidity is a function of whether things can legally trade and whether people want to buy them. Right? It should never be the case that, just because an asset is represented in token form, it becomes more desirable or that the laws change about when it can be transferred. So that argument just makes no sense to me. You could maybe see in the short term, because it’s a novelty, that when a normal share of stock is on a token forum more people want to buy it. You can also talk about 24/7 markets – right now the markets in the US are open nine to four-ish, and theoretically, if these things were trading peer to peer then you could have markers popping off all the time. But again, the appetite to buy these things still has to be there and most trading in traditional assets, for very good reasons, is done by institutional buyers or through intermediaries who curate. I just don’t see that changing very much anytime soon. So, I just don’t get the liquidity argument really.
This transcript has been edited for clarity, listen to the full Coinlaw Podcast interview here.