Building Corporations Onchain with Gabriel Shapiro

24:19Alex Thorn:Yeah. But I'm very like cognizant of the fact that we don't know everything. Yeah. And historic history tells us. We tend to get overexcited. We always get overexcited. Yeah, no, every time. Every time. It's not like a. No, it's like a natural human thing. I mean it makes a ton of sense. There's a lot of euphoria and it's not misplaced. In the case of dot com, it was definitely not misplaced. It was just a big parabolic move that, you know, it took Amazon until what? Like, you know, 08 or 10, I forget when, to get back to its absolute stock price from then. But of course, it's roared way past that.

24:54Alex Thorn:Like, people were right. The internet bulls were correct. They just got a little ahead of their skis and we tend to always get a little. What if we have the most intelligent thing that anyone's ever created that comes out in a month? Yeah. What does that mean? I don't know. A lot, though, probably. Right. But I feel safe at Bitcoin. I do, too, especially at these levels. We're not, well, just empirically, we're not close to all-time highs or anything. Like, this is, we know it can go there. It has in the past. I think if you can definitively put in and the market agrees the bottom is in, then this is a nice setup, I think, for Bitcoin.

25:30Alex Thorn:Well, we'll keep following it. And as always, very fun to talk with you, BimNet. Thanks for having me. Bibi from Galaxy Trading. Thanks. Let's go now to our guest, Gabe Shapiro, CEO of Metal X Labs. Gabe, welcome to Galaxy Brains. Thank you for having me. Well, I'm really excited to have you on, Gabe. I followed your work for a long time. You've been in the crypto law bar for a long time. You are a lawyer and a crypto lawyer, quote unquote. Is that fair to say? Yes. But for a long time and certainly lately, you have been working really on, I would call it one big giant problem, how to build companies and or equity on blockchains.

26:06Alex Thorn:First of all, am I right? Is that one big giant problem? Is that a fair way to characterize it? And also just give us a quick high level overview of like what your main focus is as a lawyer on blockchains. Yes, it is one big problem with lots of small annoying sub problems or interesting sub problems, depending how you look at it. And I think, you know, it's one of the dreams of blockchain really and a lot of different projects have taken a stab at it. If you think back to, you know, a project called Aragon, which is now, you know, primarily known as sort of a DAO protocol, one of the most important ones, obviously, still today, you know, back when it was doing its ICO and in the early days, they were also interested in, you know, what I call RWEs, real-world entities, right?

26:54Like, can you, you know, represent the shares of an entity on chain And does that open up interesting sort of composability and counterparty risk reduction vectors and so on? So and even in the Bitcoin community outside of Ethereum, there were, you know, there were a lot of like on the Bitcoin talk forums, there were, you know, tokenization projects, more so on kind of like the tokenized equity side or certain kinds of tokenized legal instruments used to raise funds for certain projects. And so it's always been part of it. And we haven't quite nailed it yet. So I'm very interested in this problem.

27:35I guess we'll get into more details about it. And in terms of why I think I'm one of the best people to add to solutions to this problem, it's because I've been a corporate and securities lawyer for, I don't know, going on 18 years now, 17 years, something like that. and I have a very traditional background. I didn't just kind of like come straight out of law school and start working on NFT fundraisers and stuff like that. I spent eight years mostly at a firm called Wild Gotchall, a big law firm, doing buy-side technology M &A. So I truly know the fundamentals. And then on the other hand, I'm a bit of a cypherpunk or on-chain maxi.

28:24And so I'd like to think I understand both sides of the issues in sort of a unique way. And I think that makes us uniquely positioned to tackle the problem and maybe, you know, really sort of solve it, you know, or generate kind of like the best solution currently possible where many others have tried and failed. Maybe fail is too strong a word, but didn't go all the way.

28:50Alex Thorn:Okay, that makes a lot of sense, Gabe. And you've talked a lot about governance of companies on chain, issuances of equities. And we're going to talk about some of these different moving pieces in a second. But at a high level, you've talked about making companies programmable, right? Bringing a company on chain or like you said, a legal entity on a blockchain. Do you mean like a normal corporation that then has like a tokenized cap table? Or is it an organization whose ownership, financing, governance, even operations actually run as a protocol? Or maybe what is the minimum viable definition in your mind of an on-chain corporation?

29:26Yeah, well, the original sort of meme that we had about this was called cybernetic orgs, aka borgs. Yeah. And my definition there is it's any entity that I think it's the most generalized concept for putting an entity on chain. And it's very agnostic to the type of entity or the functions of that entity or the purposes of it. And the basic idea is just that it's an entity that in its legal documents, in its certificate of incorporation or articles of association and memorandum of association or membership agreement, whatever the applicable legal document is, It literally prescribes that certain functions, certain core governance functions are to be performed with blockchain technology and that those are definitive when they are performed that way.

30:21Right. So, you know, a very simple example that we've used mainly in partnership with DAOs rather than for ordinary real world entities is representing a board of directors as a set of signers on a multi-signature smart contract. Right. So the legal documents of the entity could say every director must be a signer on this multi-sig and every signer on this multi-sig is a director. And so that gets you basically perfect legal mirroring between those two things. Now, why would you want to do that? Your mileage may vary and we could talk about that specific purpose. In that case, the reason was that these entities are meant to be accountable to DAOs, i.e.

31:14larger smart contract systems that may not have legal wrappers or conventional means of enforcing legal contracts, etc. etc., their main mechanism is to do an on-chain vote. And that may be really their only true, indisputable way of expressing themselves, the DAO, that is, is by doing this on-chain vote. So if you want, for example, a DAO to be able to elect directors of a legal entity, well, this would be a good way to do it, right? And it would mean that there aren't a lot of chances for someone to rug the DAO out of being legally definitive, if that's the intention. So that's just an example.

31:56You know, obviously in the real world entity case, it would be something like saying, you know, the tokens on this specific smart contract and you would name the address, you know, represent shares of this company one for one or something like that. And so having such a provision in the governing documents of an entity is what makes it a Borg, makes it a hybrid on-chain, off-chain entity, and makes it interesting in some sense.

32:22Alex Thorn:Yeah, that makes sense. One of the interesting things in the history of DAO governance, right, decentralized autonomous organizations, we used to joke like in like 21, and this is a lot truer then than now, but still kind of true for many of them that they many of them weren't quite decentralized. And a lot of them also weren't autonomous or there was a scale to which they were. But even I think more interesting for this conversation, many of them, in fact, almost all of them until much later, they also weren't really organizations in any kind of legal sense. and I remember there was one, was it pooled together?

32:58Alex Thorn:Was that no loss lottery, right? Where, you know, I can't remember. Not only was there, I think, some regulatory effort against them, but there was a lawsuit brought against them. I got maybe by some users or something. Actually, if I recall, don't hold me to this, but I think it was maybe the named plaintiff in the lawsuit was a former Elizabeth Warren staffer. That's exactly right. Yeah, it didn't seem coincidental to me is all I'm going to say. But one of the interesting things, And I think in the end, that one actually may have gotten dismissed because it was in New York law, which has like slightly better like partnership.

33:30Alex Thorn:But basically the DAOs, in the absence of a legal liability protection, like an LLC corporation, were being treated in some cases as general partnerships. And so every possible voter in the DAO, which for many of these is just like any token holder, could be held joint and severally liable. Was that one of the main reasons why these DAOs need like a legal entity footprint? Yeah, I mean, I'm not a legal rapper maxi for DAOs, but I do think the legal, the attack vector you mentioned is a real one. There's a little more nuance to it, and I've been involved in defending some of these actions as well for clients and sometimes on a sort of pro bono basis.

34:14But there are certainly unincorporated associations of some sort. it's very easy to have a unincorporated association because it just means some people are associated and there's no corporate entity wrapping them. Right. So, I mean, you and I are probably forming, we might have an unincorporated association right now.

34:32Alex Thorn:You and I were a media company right now, right? Exactly. Right. And so, but, but the question is then what, what are the legal consequences of that? And there are different types. One type is what you mentioned, which is a general partnership. And one of the adverse consequences of being a general partnership is the partners can be, you know, what's called jointly and severally liable for adverse things done by any partner on behalf of the partnership, you know, whether they knew it or not or whether they proved it or not. So there's certainly a liability vector. You know, I think the pure version of DAOs, which is really something that was formulated by a guy named Stanley Larimer, not Dan Larimer, Stanley Larimer, although I've heard that they are related like cousins or something he wrote the original where this all came from was a paper he wrote describing bitcoin as a decentralized autonomous corporation and he goes through you know yeah it's like like the miners are like people that this corporation has hired the bitcoin that is minted to the miners for adding blocks is like share compensation paid to them right and he said uh he said a series he really considered it more a species of robotics than truly an extension of corporate law, but corporate law is an analogy.

35:49And I think when it's done like that, it's less likely that these would be considered actual legal entities of some sort because it's really a software control widget, right? But people really, Vitalik expanded the concept in his essay on DAOs and other people expanded the concept. And then basically just people started running straight up companies more or less, but with no legal protections. That's a bad idea. And that's where I come and I say, well, what, why don't we just, instead, instead of calling this a Dow and just having it like a really sloppily managed company with no formalities that happens to use smart contracts, let's use an actual like legal entity, like a corporation.

36:28And we'll like, just add, we'll just use smart contracts as part of the way that it does things. And we'll formalize that and we'll make it very clear and everyone will be legally protected and so on and so forth. And we, the thing that we lose is like, okay, now these tokens are officially stock and so they have to follow the securities laws, but you know, that that's probably going to be the case either way.

36:48Alex Thorn:Yeah. Let's go, that's really helpful. Let's go into the securities laws thing in a second with the equity or the tokens or whether they're equity or whatever it is. Just before we do though, like, so there's been this long history of these types of attempts. I love the reference to Bitcoin, the miners being sort of like vendors to the protocol that makes a lot of sense as well there have been you know i mentioned pull together there's been all these yeah i remember aragon um and they were like the court to adjudicate like this dow disputes was their original idea i think right that actually it was that was their second idea their first idea was on-chain entities then they kind of did a little bit of a pivot to a court thing because dow's weren't really taking off and then they pivoted back to dow's and now we'll see a DAO project again, but yeah.

37:37Alex Thorn:Yeah. And then like Compound is often credited with being one of the pioneers in DAO governance because they had, you know, voting structure, open source, sort of like DAO governance structure. They're also obviously well known for being, you know, one of the first pure lending protocols if we set MakerDAO aside. And then also for kind of inventing yield farming as a token issuance strategy. So, and, you know, we know Robert's a friend of the show as well, but that long history, and there's many twists and turns I haven't mentioned, but today you have a cyber corp, because I guess maybe a successor to the Borg in a way, right?

38:15Alex Thorn:How do you do this today? Put a corporation on chain, certificate of incorporation, bylaws, board, you talked about board as an example. Is it just about putting the, like, instantiating the on chain portion of it in the legal doc? and vice versa? Or how does the CyberCorp work? There's different pathways. People come to it. Well, I'll use our fundraising platform as an example. So we have an app called CyberRays that's built on top of our protocol. And I think most people just go to it just because they want to raise venture financing, maybe from like angels or community members or whatever in a legally compliant way as a raise.

38:57But what I find to be the most efficient solution for that is that people sign the agreements and fund them in a single step atomically, and they get an NFT representing their investment, right? So any company that uses it, they're sort of, you know, without sort of saying to myself, oh, I want to become a cyber corp today because they are using this automated process of raising funds in exchange for securities on chain. They are becoming a cyber corp because this NFT is now a part of their capitalization structure. It represents, for example, a simple agreement for future equity, and that NFT is definitive for that safe, right?

39:37So that's one way you can, and then they're receiving the funds on chain. And so the address they receive it to, you know, is ipso facto part of their corporate treasury, right? So that's one way you can sort of come to it. Another way that people often come to it is through token launch pads. And this is in a non-securities context, But we have partnerships with three launchpads, really. One is MetaDAO, one is Umiya, and one is PumpFun. And all of these have in common that a lot of entrepreneurs are launching a non-securities token on their platform to bootstrap like a real-world business. and they wanted to set some ground rules around that token being high quality in some sense.

40:25So like, for example, the founder can't just take all the IP that was generated with the help of this token community and just walk away from it and never worry about the token holders again. So with that, basically, a founder comes on chain. They sign a set of legal agreements. In the case of MetaDAO, it uses a Cayman segregated portfolio company. That segregated portfolio company's documents say, for every new limited liability layer we create within this structure, there's a set of rules. It includes that you can't issue equity out of it, that you have to respect this token essentially as a governance token, in that case by way of a decision market.

41:07and that the signing of these documents occurs by using a crypto wallet and signing these set of docs on chain that then generates a proof that feeds into their platform and that then enables them to do a raise on the platform. And so that's another way that you can become a cyber corp is by going through that process. So what they all have in common is they use on-chain logic somewhere. They use a private key as a credential somewhere. And then the legal docs reference a token in some way.

41:40Alex Thorn:That makes a lot of sense. And those guys, a guy on my team, Zach Bacorny, has written a fair amount about MetaDAO and Umiya. Ownership tokens is like... Yes. And what is that? Those aren't securities, right? Or I guess they could be, but... Yeah, it's a little bit... I mean, it's a little bit of a misnomer that caught on. what those particular entities do is, number one, they create a certain alignment by setting the ground rules I mentioned. There's a certain entity that everyone knows and that has an on-chain identity in our CyberQuark registry that owns the IP related to that project. Number two, if they want to ever sell that IP or do a major license of that IP or something, there's a rule in the legal agreements for that, Andy, that says you have to use this DAO, this on-chain DAO, as your decision oracle or as part of your decision oracle for approving that, right?

42:35And there's some other rules, like they're actually not allowed to issue equity to themselves in that particular case. So even though the tokens don't have rights, like they're not equity shares, there is a rule saying that there can't be something that competes with the token, which at least somewhat helps for alignment. So, you know, we try to stay on the right side of the line there. But ultimately, it's a token community that has legal protections by virtue of the related legal entity being a cyber corp or being a borg and having to follow these rules.

43:09Alex Thorn:So Gabe, let's talk about tokenized securities and the different forms of them that exist in the market today. You wrote a great piece on X, I guess, a couple of months ago at this point where you had your own very well-informed categorizations. I often use the SECs like issuer sponsored, third party sponsored. Maybe give us an overview though of how tokenized equities in particular exist on blockchains today. Then obviously we'll talk about like where we think it is going, where it should go, but give us an overview of how you see the landscape today. Sure. Yeah. I mean, I like to refer to this as the ontology of tokenization.

43:43You know, obviously in some sense you want your token to like be a share, but if you really think about the underlying legalities and so forth, it can be a lot more complicated than that. So what I would say the vast majority of tokenization in the market today is what I call pointer tokenization. And what pointer tokenization means is that, yes, there's something happening on chain, it may have some legal significance or implication, but ultimately what it's doing is it's pointing back to some type of off-chain database, which may be DTCC's private off-chain regulated database. It may be the master security holder file held by a regulated transfer agent.

44:31It may literally be the, it may be Carta. It may be a cap table on Carta, right? It may be any number of things, but it's something off-chain. And that off-chain thing is actually the definitive securities ledger in one sense or another, right? And so now there are different flavors this pointer tokenization can come in. One of them is like, and this was sort of, I would say, earlier tokenization thing some years ago, is they literally have no legal meaning. There was called a souvenir, right? And you could go back to some of the early offerings. I forget which one it was, but in one of my articles, I have a quote from like about, you know, how they're saying that, you know, computer shares ledger is definitive, you know, and you get a token that sort of shows you that you have an entry on computer share.

45:21Right. And it's really nothing more than that. The more recent trend and the one that, you know, the SEC seems particularly interested in in cooperation with DTCC and others is the idea of an instruction token. It's the concept that when a token is sent from one address to another, that constitutes an instruction to a transfer agent or to DCCC or to whoever that they're supposed to make a corresponding legally definitive change in their off-chain definitive securities ledger. So how this might work is that there's a set of blockchain addresses that off-chain are correlated to the names of people and institutions, et cetera.

46:04And so those addresses are whitelisted in advance. A type of securities token is able to transfer between any of the whitelisted addresses. And so the transfer agent always knows which address belongs to whom. And it could say, oh, this address is Alex Lawrence. This other address is Gabe's. He sent 20 of these tokens to Gabe. That means 20 shares of Apple. So we're now going to make a change here that says Gabe owns that credits Gabe with an extra 20 shares and debits Alex from 20 shares. Right.

46:37Alex Thorn:So that's pointer tokenization. it's clear that a lot of the if not all of the uh real quote-unquote the tokenized equities on today are those what about like tokenized equity products like xdocs ondo what i would call the third-party issued tokenized equities or i guess what the i think what the sec would call them are those pointers or are they something else uh it depends i mean uh those that's a question of wrappers, right? Whether you're, whether, like, let's just say you want exposure to anthropic stock, right? The one question is whether you would be somehow getting that exposure directly, like most likely with the cooperation of anthropic in some sense, right?

47:24Or whether you're getting it through some kind of wrapper, like someone has acquired anthropic stock, They're not able to sell or give you that Anthropic stock because Anthropic doesn't want you to own it. But what they can do is they can assign you to some trust, some LLC, some type of other entity, broadly speaking, SPVs. And then they can issue you some type of equity interest in that SPV or that trust or whatever. Whether it's pointer tokenization or what I call constitutive tokenization, that can apply at any level. You could have a wrapper and you could give someone a token that is a pointer to your rights in that wrapper.

48:06Or you could have constitutive tokenization with a wrapper, or you could have pointer or constitutive tokenization directly for the actual ultimate security that you want to own. So it's kind of like two dimensions. Right. What constitutive tokenization is, I should probably explain is and why it's different is basically where the chain itself is the definitive securities ledger for for the security in question. Right. And there are different ways you could imagine doing this. And it is actually authorized under law, like, for example, in 2017, Delaware amended its corporate code to to allow for distributed electronic databases to serve as stock ledgers.

48:46The way that we do this at Metal X is with NFTs. We basically say each NFT is an entry on the definitive securities ledger for the issuer. And so and literally what it looks like, it will say, you know, for example, Gabriel Shapiro owns 10 ,000 shares of Metal X Labs or whatever. Right. So it looks a little bit like a stock certificate or something like that. And you can actually, that way you can actually truly put your stock ledger on chain and that would be constitutive. The somewhat confusing aspect of this is that like there are hybrids. So like, for example, Securitize likes to say, like they would probably say that they use constitutive, but it's really like partially constitutive.

49:32Because what they do is they have an ERC-20 token. It includes a hash. And that hash is back to their off-chain transfer agent database. So they sort of consider this like a hybrid. Like they partially use the blockchain as a security ledger. But at Metal X, what we're trying to push is like fully using the blockchain as a security ledger. Or in any event, like much more so. Because what that really means is that the state transition function of the blockchain can also be a legal transition function. Like you can literally mutate the data of this NFT from Gabriel to Alex. And that means that Alex is now, you know, the legal owner.

50:16And there wasn't any type of transfer agents off chain system involved in that just by virtue of the state transition functions of the blockchain itself, a legal settlement occurred. And that would mean that that blockchain is truly the legal settlement layer for those securities and opens up all kinds of potential composability avenues, et cetera, and trust minimization avenues. You know, that wouldn't be there if you're using more of a hybrid system or if you're using pointer tokenization.

50:43Alex Thorn:Yeah, that makes sense. That's like a native tokenization, you, I think, called it. And we don't really like maybe you guys or do you guys have native or cyber corpse with Metal X or the other platforms? Are they doing native tokenization today? Yes, we do. Yes, we do have that today. So, for example, everyone who's used our cyber raise platform and sold like a safe to invest in their startup, that safe is represented by an NFT. and that NFT is a definitive legal representation of the ownership of that safe. Now, what I would say is that currently Metal X securities token users have generally been early stage startups.

51:26So the securities are illiquid. So you don't get into a lot of the sexy liquidity stuff that a lot of people think is where tokenization gets most interesting. But we have literally just finished the audit for our liquidity protocol, and we have a great partnership that I guess I can't name here because of confidentiality clauses and such that do the type of tokenization you mentioned with wrappers, with SPVs. They specialize in that, and they will be tokenizing on Metalix's protocol, and they will actually have a market in those securities. It's not fully liquid, but there are certain exemptions that you can do even for unregistered securities, like you can do a 4A7, which is accredited investor to accredited investor.

52:14You can do a Rule 144, which is someone who's held the security for 12 months or more. And there are certain information requirements that have been satisfied with, you know, just a simple publication, really, of like balance sheets and such. And so we will soon see securities that are tokenized on the MetalX tokenization protocol actually trading, which will be very cool.

52:41Alex Thorn:Very cool. One more example, if you wouldn't mind, Galaxy stock tokenized on Solana with SuperState as the technology partner, but also transfer agent. Based on your categorization, this seems very clearly like direct pointer tokenization to me, right? We have the TA with the master security file. In fact, it's actually two TAs because we have our traditional TA, Equinity, and also SuperState. And combined, they can create the security file. every token is uh you matches shares on the security file um and if they move they get updated in the security file right um so is that is that type in your sort of end state that's a transitionary design right it should ultimately maybe if galaxy had issued which we haven't but if we had issued new shares like primarily on the blockchain then maybe those could be native it's Do you view the corner too as like a bridge between traditional and - Yeah, it's a bridge.

53:42And look, there's absolutely nothing wrong with it. None of these things, it's not like I'm saying pointer tokenization is bad or something. But I think the ultimate thing, the ultimate benefit that crypto usually provides, including if you look back at the original Bitcoin white paper, much of the point of it in Satoshi's mind was that it's a peer-to-peer value transfer system, right? And what you just described is obviously not peer-to-peer. It's highly intermediated. It's convenient. It has certain composability efficiencies, and you can reach more people and reach more venues and so on by virtue of what you described, which are all very positive things.

54:19But it's highly intermediated. One might even say it might be more intermediated than in the traditional case because you have multiple transfer agents now. Right. So what you would want to do if you were doing constitutive tokenization is you would actually amend your bylaws. You would amend your company's bylaws, which is what I've done with Metal X Labs, for example, to say, OK, the board can declare that certain shares are tokenized. Right. And for those shares, such and such smart contract on such and such blockchain is the definitive securities ledger for those shares. Right. Right. And so that would then make it constitutive.

54:59And now now those would be in our protocol, those would be NFTs. We have a way of converting those into ERC 20s for DeFi composability, et cetera. And then you are now back with the ERC 20s. Inevitably, they're not registered positions, so they don't have the same rights. Right. But what you can do is you can have like conditioned smart contracts, et cetera. So it's all very clear how you would convert back from, you know, unregistered positions to registered positions and so on. But ultimately, it all comes down to one thing. The legal documents of this issuer have to explicitly authorize this and make the blockchain a part of their securities ledger.

55:39Alex Thorn:Right, and not be solely relying on the TA and the existing infrastructure. infrastructure. This is why I sort of think of it as like, you know, assuming we get to the more composable native end state, then sort of pointers are sort of like a like a bridge to them. You know, it's like a bridge to the next. It's it's it's sort of like easy to do today. I know when we did ours, you know, the division of corporation finance, which regulates corporations and issuance right um at the sec they didn't really have any questions about actually allowing for the in our case not an issuance but the conversion of traditionally formatted shares into this tokenized version this pointer um because it's kind of allowed technically it's really still the same thing as a traditional and maybe that's why it wasn't as controversial what has been they're basically they're they're really tokenized broker broker entitlements right yeah um and and And we understand that very well.

56:37It plugs and plays very well with the traditional capital markets.

56:42Alex Thorn:But we also know what is controversial. I'm going to go to Red Crypto in a minute, but let's actually go in the out of order. Let's talk about the innovation exemption. One thing that we have not done, because of the way Galaxy stock is designed on chain, it requires allow listing for every address. So you can't, unlike a stable coin, which may be like KYC at the point of create and redeem, but otherwise can float between unknown addresses in the market, which thank God they can because otherwise they wouldn't feel a lot like dollars. Ours cannot be transferred to any address that hasn't been previously onboarded and whitelisted.

57:17Alex Thorn:I don't know if that's ultimately required, and maybe I'll ask you as an aside, is that actually the law? It's not quite clear, but I'll tell you why we didn't fight that one, is that that wasn't the more interesting question to me. The more interesting question was, is there demand to trade tokenized stocks in true DeFi and also will the SEC allow it? And so rather than biting off the whole KYC allow list question to also fight, I said, let's focus all our guns on the secondary trading of securities. Maybe quick thoughts as a lawyer on is that is allow listing actually required? What's very interesting about the securities laws is that actually fundamentally peer-to-peer transactions in securities are permissible.

58:01This is actually meaningfully different from certain other areas. Like, for example, commodities derivatives, at least the really big ones, the swaps, they're not actually allowed to trade peer-to-peer, right? Period. They can only trade on licensed markets with that intermediary. But securities fundamentally are supposed to be allowed to trade peer-to-peer. It's very uncommon. Why it's very uncommon is because they had previously traded peer-to-peer on paper certificates. That became very inefficient, so we decided to dematerialize everything. And at the time that we did this, which was basically in the late 1970s, early 1980s, there was no such thing as an ownerless electronic database.

58:48Someone always had to own an electronic database. And so we set up these sort of, you know, quasi-governmental entities like Seed & Co. and DTCC that have to own that database, right? And that's how we solved it. And so almost all securities transfers today do occur on an intermediate basis, but it's not due to a law that that has to be the case. So now that we have ownerless electronic databases and we have, you know, sort of like self-service, you know, custodial, like non-custodial asset accounts through blockchains, it's time to revisit these assumptions, right? Now, why in your case, naturally, they would have to be whitelisted is because it is intermediated.

59:31That transfer agent or that broker, they're subject to FINRA rules and other regulations that may require them to have elevated KYC requirements, as opposed to if you and I are just transacting peer-to-peer, we're not institutions, we're trading for our own account, we have much lighter rules. So that's one of the reasons why I want to bring this constitutive model on chain. It would get rid of all the intermediaries or go back to you and me just transacting. The requirements would be much lower. And, you know, I, of course, I'm still as an individual, I'm still obligated to, for example, comply with OFAC sanctions.

1:00:08But one of the things we do on Metal X is we have a ZK passport integration. Someone just scans their passport on their phone. It generates a local proof that they're not on the sanctions person's list. And then I transact with them. I don't need to get their proof of address, collect their passport myself, and all these things. So that is where there is an arbitrage between this pointer model and this tokenization model, and this, sorry, this constitutive model. But fundamentally, it should be allowed and we should be able to get there.

1:00:36Alex Thorn:Yeah, that's very interesting. So the innovation exemption, though, is said to allow for probably time and maybe even volume limited secondary trading of tokenized securities of some type in decentralized trading venues, I'll call it. we have wanted to try to effectively, I mean, we're on Solana, so it would probably be Orca or Radium or something like that. But effectively, the question is, I believe that there are certain venues that truly are decentralized. Can we trade stocks there? And is the market interested in trading stocks there? And I say that second part because I think the market, at least a sufficient enough portion of the market for it to be a viable thing to do is interested.

1:01:23Alex Thorn:But I'm totally willing to admit that we don't quite have an idea because we've never really been allowed to try. And that's what we think the innovation exemption is going to let us do is try. And I guess - Yeah, I've heard different things about it, but what it should be considered next to though is also the covered UI provider guidance that the SEC released in March, because that was very interesting. And it basically said, hey, if you're running a front end for basically a DeFi protocol that happens to trade tokenized securities, we're not going to call you a broker. Even if you take transaction-based compensation, which if nearly any lawyer other than me, you had asked before that thing was published, you take transaction-based compensation in securities transactions, that was an automatic you're a broker to almost every lawyer.

1:02:10And they said, no, you can take it. You're basically a technology provider. You happen if you get paid that way, right? And so, you know, I think that is very bullish for, you know, a DeFi style of tokenized securities. Now, they didn't get into, well, is it DEX? Is it DEX also out of the rules or, you know, all these other things? They just dealt with the web app. But there's an implication there. Now, what I think the innovation exemption is most likely going to be about is not all securities in general, but specifically what are called NMS securities, national market securities. So these are securities that are registered with the SEC already that, that already trade in this highly intermediated context that we talk about, et cetera.

1:02:57It would be no surprise to me if the rules for those have to start out a little bit more conservative, right? And that is why with Metal X, we started out with private securities because I want to have as few restrictions on my experiments as possible. Right. And so, so, so the hope is that, you know, I, again, I think legally speaking as a lawyer, I don't see any hurdle to a private company's securities trading on, trading on a DEX. Now that it requires that company may not know at all times, like who, who the relevant beneficial holders are, et cetera. But as long as they're not paying them a dividend or something, I don't think they're violating tax rules or any other types of rules.

1:03:44So I do think it's possible, but I would be shocked if we go straight to that DGEN version for NMS securities. And of course, they are regulated. So the SEC would have power to impose certain additional constraints on those, et cetera. It's not just private ordering, right? So that's my intuition of how this will go down. But of course, I'm speculating to an extent.

1:04:07Alex Thorn:Yeah, there was a Bloomberg story in May that the SEC was on the verge of announcing innovation exemption and that it would include third-party issued tokens. Then there was some back and forth, apparently, at the commission and probably with stakeholders. And that same week by Friday, another Bloomberg story came out saying, just kidding, it's delayed. And now, you know, I think it makes sense separately from that. My understanding, again, from following the public reports, is that which types of tokenized securities would be able to afford themselves of the innovation exemption is a question.

1:04:49Alex Thorn:I think ours, pointer or otherwise, Galaxy Stock is an issuer-sponsored tokenized security. Exactly. The issuer, we say, this is our stock. And, you know, yes, it may be a pointer, but we, the issuer, at least publicly pledge, perhaps we should put it in our bylaws. but publicly pledge that if you own the token, that's our stock. We count Pari Passu as our stock. I think everyone knows that's probably going to be allowed, but that hasn't scaled well because, you know, if you're super state or securitize, as I know two companies that build these types of tokenized securities, you got to go and get every single issuer to do it, right?

1:05:25Alex Thorn:Like, and it's like, that's not, whereas if you are X stocks or Ondo, you effectively buy a bunch of stocks or base, we should say, which I think just announced while we were talking, Um, they're the launched, I think they're tokenized stocks. Um, they're just buying stocks, putting them in a legal vehicle of some type, and then tokenizing typically the shares of the vehicle. Um, and that's what you have. So as a wrapper model that I think is one of the main disputes that we're all waiting to see as it, as it should be right. Because, you know, it is, it's a little bit of a gorilla technique, so to speak.

1:06:01And, you know, one could make the argument that, you know, issuers should have the right to determine how their stock works. Right. And there are all kinds of harms that an issuer could. I mean, they can get some benefits from it, obviously, more distribution, et cetera. But there are harms that they could have, like fragmented liquidity, right, by having all these different wrappers that are. Investor confusion.

1:06:26Alex Thorn:Confusion. Exactly. And the legal arrangements for these wrappers are often very unclear, right? Like, you know, you mentioned three different ones. You know, I haven't been able to find the documents for Coinbase's offering, but I have a lot of respect for their legal team. I know some people on their legal team. And, you know, it sounds like it's some type of trust. And, you know, I have to imagine that you have some type of right as a token holder. I don't know exactly what it is, how it works. I don't know if you're technically a beneficiary of that trust or what, but there's going to be something there, right?

1:07:00For some of these, like you mentioned, X stocks, I mean, it may have evolved over time, but when it first launched, I looked at it. And immediately my mind went back to my first contracts class in law school where we learned about something called an illusory promise. Because it didn't actually provide the token holder with any rights as far as I could tell. It basically just said, uh, at most, I think later they added a one type of right. They said you have the right to request a redemption, right? Um, um, but, but, uh, uh, but in the first version, it didn't even say that it was basically just, uh, like a hundred pages of disclaimers saying they don't have to do anything at all.

1:07:39And they don't publish the documents for the SPVs. They don't document the chain of title for how this particular SPV came to own SpaceX stock or whatever it might be, you know? And so there's a lot of risk there. And there's also the risk that if these things trade in certain venues, you could get something like you could get price differentials between one venue or another, and it could potentially infect another market. You could say, oh, on Jupiter Dex, the price of SpaceX shot up 150 % today. Is someone insider trading? Does it mean something? Is it just manipulation? And then it's conceivable that NASDAQ could have a reaction to that and that could affect the price at NASDAQ, right?

1:08:27And so issuers need to care about these things and they probably want some measure of control over it.

1:08:33Alex Thorn:Yeah. Yeah, that makes a lot of sense. And just for the backstory here, a little bit on base, this is just put out today, but here's, this is all I can see in their blog here is this paragraph, a Coinbase tokenized stock is a real share that you actually own on chain authorized participants, which are institutional market makers buy the shares those shares go to alpaca a regulated broker and custodian in a bankruptcy remote structure that's the unknown legal structure uh supervised by abu dhabi global markets adgm regulatory authority if you hold the token you hold a direct claim on the share coinbase tokenized stocks are the real deal that's pretty much all i can see there the paragraph kind of contradicts itself because it says it's a real real share you own on chain and then later It says it's a claim that you own on the share.

1:09:19But, you know, I mean, the important thing is that you have some legal rights and that those are documented and clear, you know, and as long as that's the case, then I think people are acting ethically and there's some utility. You know, obviously, more precise marketing is something I'd prefer, but it's understandable. Yeah.

1:09:35Alex Thorn:Well, it's one of the things that I've learned as a non-securities lawyer, though I did work in securities compliance and litigation for a long time in my early career, but is that like many things, when you start looking at them, certainly things as complicated as this. Nobody really knows what they own when they own a stock. Nobody really knows how the stock market works, like from an operational standpoint. And by the way, even experts that I know have a hard time explaining how, you know, it's like we need like how a bill becomes a law, but for like how a stock trade settles. Yeah, people only care about this stuff when something breaks, right?

1:10:09Like with the GameStop incident and the naked shorting or, you know, another big one that happened is this is a great case for constitutive tokenization and disintermediation. And by the way, it's a famous one in the in the Dell, in the huge Dell take private transaction, you know, maybe maybe 15 years ago now. I don't remember the it was very controversial because it was, you know, Michael Dell taking private his own company on and he knows more about the company than anyone. Right. So people like, is this a fair price or not? And there was a very large institutional holder that wanted to exercise, that wanted to vote against the deal.

1:10:49Because if you vote against the deal, you get, or you don't vote in favor of the deal, you get in Delaware what are called appraisal rights. Where after the merger is closed, you can go to court and you can say, look, they sold it at$7 a share. I can prove these are actually worth$14 a share and I want my$14. But you lose it if you had voted in favor of the deal.

1:11:11Alex Thorn:I see. And so they wanted to vote against or just abstain. And they put in their vote with their broker and it flowed up through a chain of intermediaries and ultimately was voted the wrong way. And so then they went to Delaware court. They said, don't hold us to this vote. We never intended this vote. And the Delaware court said, you're out of luck. You didn't own the shares. You're not the voter. And the voter voted this way and you're stuck with that. Right. And so these things, when these things break, people do care. But they don't break terribly often. And often it's the institutions or something like that that gets hurt.

1:11:46So there's not necessarily a popular consciousness of this issue, but this stuff matters.

1:11:51Alex Thorn:Yeah, you know, there's that great tweet from Neeraja Garwal from Coin Center when he said like, oh, I'm sorry that your decades of surveillance regime was like built upon the premise that we would always need intermediaries to transact. Exactly. And it's kind of like, oh, I'm sorry that your securities law regime was built on the premise that we'd always need intermediaries to transact. Exactly. So one of the reasons I feel like we can, for example, we were able to tokenize Galaxy stock is simply because they just never really conceived that a TA would do something like this. There simply aren't rules.

1:12:26Alex Thorn:Not that there even shouldn't be. There probably will be rules on TAs related to this one day. um and same thing like uh you know so much of our capital markets and stock market trading apparatus all of the rules are on like broker dealers and exchanges right like all of them basically um so you know things like best x you talked about reg nms so the national market system galaxy stock is a reg nms stock so when your broker helps you buy or sell galaxy stock they have a number of obligations including trying to get you the best possible execution price I get asked by SIFMA and others in the traditional space when we talk about tokenized equities, well, how are we going to get best X on a DEX?

1:13:08Alex Thorn:And I'm like, well, first of all, I've got some good answers that you generally might like. If we can open the connectivity and the plumbing, then there'll be good ARB and the prices should be okay. But actually, that's totally irrelevant because best X is a broker-dealer rule and there ain't no broker-dealers involved in our process at all. So it's like this new frontier here of we're not just dematerializing the stocks back into a native digital form. We're kind of dematerializing the whole system. Exactly. And so, you know, it's even, look, some people care about decentralization and are cypherpunks.

1:13:41Some people don't. But what I like to say, like even to just like market maxis who are more like trader types who don't care about these things, what I like to say is like disintermediation is going to get you like the purest free market form of this for the arbitrage reason that you just mentioned. So you should like you should support the decent the decentralization and the disintermediation as well. Right.

1:14:04Alex Thorn:Yeah. It saves money and it is it is pure free markets or it's pure. I mean, you know, there's going to be rules and stuff, too. Gabe, before we finish up, and I know it's a little different, that's why I saved it for last, but Red Crypto Assets came out. I know you've submitted a bunch of stuff and talked to the commission about this and the innovation and all of this stuff, as we have too, although I did not really work much on Red Crypto. I've been focusing most of our commentary publicly and with the commission on the innovation exemption because of secondary trading. I don't know, maybe give just a really high level on Red Crypto, just what it is for the audience.

1:14:39Alex Thorn:I wrote a piece about it in our newsletter last week. So if you're listening, feel free to read that. I don't want you to go too in-depth. Then I just want you to talk about like, where does this fit in? Is this just primary issuance of like ICO 2.0 or does it have some relevance for the launch pads? Yeah, definitely. Definitely the easiest way to think about it is that it's legalizing ICOs. You know, ICOs are capital raising transactions where the asset sold is a token or a promise of a future token, right? And obviously they're a super popular use of blockchain. They're a great financing method for blockchain-related projects.

1:15:12And this is creating two new securities law exemptions where you can legally raise from unaccredited investors, as well as accredited, obviously, if you want. You can mix the two by selling tokens, right? There's three tiers. In effect, there's a$5 million tier that doesn't really have significant disclosure obligations. And, you know, you could consider it similar to like Reg D or some of these existing private market securities law exemptions, but more liberal in the sense that you can sell to unaccredited very easily. And then there's sort of a bigger tier for up to$75 million, up to$20 million and then up to$75 million.

1:15:54And those two tiers are modeled after the existing Regulation A +, which is sort of considered like a mini IPO. And these have, you know, more formal disclosure obligations that you have to file with the SEC, including financials unaudited for the$20 million tier, audited for the$75 million tier. And the basic idea is like, look, people are buying these tokens. They're not like stock, right? They don't have like long-term contractual rights, expectations of dividends, expectations of mergers and all these things. They're essentially non-legal, but people promise things in connection with that and they should have to fulfill their promises, right?

1:16:37So you get four years to sort of do what you said you did as part of this implied investment contract and you have to make disclosures about it. And the idea is like you're going to complete this, right? It might be, for example, you know, obviously Ethereum was an ICO and Vitalik went out and made a bunch of promises about building like Bitcoin plus like these things called smart contracts that are like, you know, much more programmable. Right. And, you know, and one day we'll first will be proof of work and that'll be proof of stake. Right. That was the core promises involved in the Ethereum ICO.

1:17:10So, and he went out, he raised the money, he used the money to build that. And I would say that investment contract was completed at the time of the merge when they switched to proof of stake. And, you know, then from, he would have been able to decertify at that point and ETH transactions would no longer be under the securities laws. So that's the basic idea. I think it's great. I think even non-crypto companies will use it. Like if you remember the 2017 ICO craze got shut down when non-crypto companies started doing it, like Telegram and Kik and others. But with this, there's no decentralization requirement.

1:17:44There's just the requirement that you have promised something that can be done in a limited amount of time. So I think normal companies will use this. It'll make their users have crypto wallets and get on chain. It'll add more capitalization options for all kinds of companies. And it'll be great. There are a lot of question marks around it because it's not the same thing. You know, it's like a one, maybe like 10 % of what's in the Clarity Act. So, you know, there's no rules for how like the exchanges are going to get regulated when they're now trading these tokens that are covered by the securities laws.

1:18:18And there's like definitely a lot of implementation questions here, but generally it would be very positive if it's adopted.

1:18:24Alex Thorn:Yeah. And it's proposed rulemaking, actual proposed rulemaking. It's not an exemptive relief or a guidance. So this is going to go through comments and debate and voting by the commission and blah, blah, blah. So presumably some of these questions, hopefully all questions, will be resolved in that process, right? I doubt all. I'd be very surprised if all of them are resolved. But, you know, I plan to comment some things, you know, like generally I'm happy with it. But like, there's a very heavy US nexus requirement for the upper two tiers. And I think, you know, that would probably lead to some unintended side effects.

1:19:03There's, I have some questions around like, you know, for the, for the upper two tiers, you have to do a verification for non-accredited that they're only, you know, investing like a certain percent of their net worth. So what does that mean for, you know, on-chain style offerings, like a MetaDAO, like, do we have to do KYC on all these people now? You know, can we rely on representation about it plus a reasonable belief, you know, things like that are currently unclear. So I think those will definitely or hopefully be clarified during the comment process, but then they'll have to do more rulemakings or something for, for a lot of other stuff.

1:19:36If the clarity act doesn't pass.

1:19:38Alex Thorn:Yeah, I agree. And I've heard, I've heard, and before we wrap, I just, I've heard some people say that, um, they're worried it's too lenient. Um, and so it could create like, you know, uh, truly an ICO 2.0 craze, like all the ugly along with the good as well. I kind of had a different view, though, which was like, I think a pretty big risk to it working is that it's not lenient enough and that issuers, whether because they're offshore already and they don't want to re-domicile in the U.S., maybe for tax purposes they can't or don't, or it's not economical, but that they may, basically a Reg D offshore offering, which many have done for, like, in this interim period between 2017 and today, would just still be more advantageous.

1:20:21Alex Thorn:And so they just would not choose to use it. And because it's, you know, it's good, it means well, it's a great, but maybe it's just too onerous. And so while some use it, a lot just continue on like they've been doing. Yeah, certainly. I mean, I think the 5 million tier will be very widely used because you could stack it with Reg D. It has minimal disclosure requirements unless you sell it unaccredited. So why not, right? There's really no downside to it. But the other tiers, though, do have pretty burdensome disclosure associated with them. And so, you know. And you need approval, too, at those other tier levels, too, right?

1:20:59You need what's called qualification. Yeah. Which is. Yeah. Yeah. And so all of it does depend.

1:21:05Alex Thorn:The$5 million, we can just go ahead and raise. Exactly. Do our required disclosures and move on. Yeah. Yes. So certainly that one will be used to others. There is a question mark. And it's the same thing with any type of crowdfunding, like with the Jobs Act and Reg A Plus and Reg CF. Those who can raise a lot, like, generally, if you're a really good project, you can raise money with very low friction from VCs, et cetera, right? So, like, it's the rare case that you can raise$75 million in a public process and you couldn't be able to raise$75 million from VCs, et cetera, right? So there's always this adverse selection question of like, will this really be used?

1:21:45Will it only be used by crappy projects? Blah, blah, blah. Countervailing to that, though, I do think, number one, even really great crypto projects have shown a permanent interest in wide distribution to retail. And the airdrop thing kind of didn't work because people just dump because they have no skin in the game. So the projects do have even really, really good ones like to be able to sell tokens to retail. Uh, even if it may be at a very cheap price, maybe it's not primarily to get the capital, but more of the distribution, but they like it. So, so that's a countervailing consideration. The other countervailing consideration is, um, you know, uh, will this just end up being a shelling point for like a bunch of like more messy, fuzzy logic type of reasons for the industry, right?

1:22:33Where it's just like, well, you know, a mark, a good market maker is not going to work with you unless you've done this. Right. because they like the disclosures. A good CX is not going to list you unless you've done this. So there's a factor where it may just become more of a shelling point thing, even though it's not strictly required. That's also my pushback to people who say, well, the SEC is cabining this to only people who make promises that they'll do something. So people will just stop making promises. Theoretically, that is a move that you can make. And we'll see how it goes. But I kind of have the sense this will just become a shelling point.

1:23:07And so even though not strictly required to make promises, et cetera, teams will end up just wanting to opt into this framework. We'll see.

1:23:14Alex Thorn:Yeah, the market will kind of demand it. And, you know, at least the best projects will do it. And that'll create some competition there. Well, Gabe, we could go on and on. And I really appreciate it. And we ran a little bit long here. But I wanted to thank you so much for your work and the conversation is extremely interesting. Everybody check out Gabe on X. And I don't know where else. Maybe tell people where they can find you, Gabe. Yeah, I'm L-E-X underscore N-O-D-E on Node. That's kind of, sorry, L-E-X underscore N-O-D-E on X. That's kind of my main place where I publish pretty much everything.

1:23:50Metal X is metalx.tech. Check out all our apps, Cyber Race, Cyber Corpse, kind of like on-chain CryptoCarta, on-chain AngelList, everything you could want. And yeah, I'm around and I'm very findable and happy to talk to anyone. Thank you for having me on.

1:24:07Alex Thorn:All right, Gabriel Shapiro, CEO of Metal X Labs. Thank you so much for coming on Galaxy Brains.

1:24:18Alex Thorn:Thank you for listening to Galaxy Brains, the weekly podcast from Galaxy Research. I'm Alex Thorne, head of firm-wide research at Galaxy. Follow me on X at Intangible Coins. Follow Galaxy Research on X at GLXY Research. Read our written reports at galaxy.com slash research. And don't forget, if you like Galaxy Brains, to like and subscribe on your favorite podcast platforms like YouTube, Spotify, Apple Podcasts, and more. We'll see you next time.