Landmark U.S. Crypto Bill Progresses (Polygon Labs' Chief Legal Officer)

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1:36What's up guys, it's Ash Bennington. Welcome to Real Vision Crypto Daily Briefing. Joining me today is Rebecca Reddick, Chief Legal and Policy Officer at Polygon Labs. Rebecca, welcome to the show. Thanks so much for having me. I'm excited to be here. There's a lot to talk about in the legal and policy world and crypto. Boy, there sure is. I was going to say it's great to have you here and especially great to have you here in this particular context. Lots going on. Obviously, the Ripple XRP ruling roiling the space a bit a couple of weeks ago. And now we've got FIT 21 Clearing Committee. How do you think about the overall landscape right now from a regulatory and legal and compliance perspective in the digital asset space?

2:18I think it's actually a really exciting, I mean, to say an exciting time in the legal and policy world, but it is because I think we've seen various types of regulatory clarity come forward in other jurisdictions in the world. Obviously, the EU has MECA. The UK has been building out a really strong regulatory position in crypto for a long time, and obviously a lot going on in Asia. And I think people have questioned, is the US going to be able to catch up or especially questioning it because the U.S. has been such a leader in tech. And I think we're there now. There is getting to be some regulatory clarity, especially with FIT, going through two committees, both the House Financial Services and the House Ag Committees, and likely going to be making it to the entire House floor very soon for a vote.

3:02So I think it's really exciting. So let's talk about the substance of this bill. What's the purpose behind it? How does it frame out the new regulatory framework? And why is it so important? It's really important because it it really answers the question, what are these tokens? And just to bring in the Ripple case that you mentioned a little bit, there's been a long time where the SEC has said, all of these tokens are securities. We don't really need to distinguish, but obviously they've had to bring cases to really get that parsed out. One of the things that the Ripple court did very well is said, no, these tokens on their own, these are assets and the assets are just software.

3:40They're not securities, but transactions in these assets can be securities. And one of the things that FIT does very well is that it parses out when you have a certain type of transaction, that's a security transaction, the tokens are wrapped in that, and during that period of time, the SEC has jurisdiction. And then it really takes it through what the SEC has been doing with the Howey test and says, when you get to a point of decentralization, it has a number of different factors that it goes through to look at it, whether it be tech development or marketing or things like that. You can go to the SEC and get certified that your token is no longer within the SEC's jurisdiction.

4:19And then it goes to the CFTC for oversight and its jurisdiction. It also parses SEC versus CFTC oversight of the trading platforms on which these tokens will be trading and puts a lot of consumer protection around there by way of disclosures and AML and things like that. So I think it's very important. All right. There's a lot to talk about there. Let's walk through it slowly. So first point, obviously, I want to talk about Ripple a little bit, XRP, I should say, and the context that this sets up. So one of the challenges that we have is that the securities laws framework here in the United States are about 90 years old, 1933 Securities Act.

4:59You have rulings from the 1940s in the case of Howey that determine how that act is applied. What is understood to be a security, the famous four-pronged test we've talked about here so frequently. One of the sort of bizarre things, I think, about the XRP ruling, and you said it very well there, better than I'm going to do when I try and paraphrase it. But this idea that the underlying tokens are, in fact, just assets, but the manner of sale made them investment contracts and therefore securities has this kind of, well, I don't want to say perverse, but almost bizarre sort of effect of creating this situation where you have essentially, at least as I understood Judge Annalisa Torres' decision, which is to say not very well, this idea that effectively what you have is institutional investors having, it seems, greater protection under the laws than retail.

5:47investors. That just seems like a kind of a weird unintended consequence. I do think it's an unintended consequence. But one of the things that I think is important to say, to take away from it is when you're saying something is an investment contract, this idea that there's a contract is really inherent in the analysis. I know that Ripple tried to make that argument that you have these predicate ideas that you have to satisfy before you can even get to Howie. And the court said, and they said a contract was one of them, and the court said, no, not true. But there is this sort of throwaway line in the decision that says, even though I didn't look at all three predicate factors that Ripple brought up to even get to Howie, I do think that you need to look at whether there's a contract or not.

6:32So that is where I think the odd result comes from in terms of consumer protections and whether you have, you know, SEC oversight of these tokens for retail transactions. So, you know, in the invest in the institutional investor context, there were token, there were contracts for these, the sale of these tokens. And so I think that's where certain representations were made in the process of selling them to the institutional investors that did not exist when they were sold on network to the retail investors. Right. And one of the things that Judge Soros's decision says is, when XRP was doing these programmatic sales on exchanges, they didn't know who they were selling to and the buyers didn't know who they were buying from.

7:17So no real contract. But by that logic, couldn't a security that was sold online meet essentially the same test? I don't know who I'm selling to. You don't know who you're buying from. The idea being, how is it different? No, I think it's very different because let's say you're just selling traditional equity. I mean, even if you have digitized equity, there are these ideas and representations from the company where the shares of which the equity represents that gives you a privity of contracts. So no matter where you buy it, I mean, you usually don't buy equity from companies today, maybe in, you know, very early, you know, series day or seed series types of fundraisers.

7:53But when I'm buying stock of Apple today, I'm certainly not going directly from Apple. And I'm not even going directly to the New York Stock Exchange. I'm going through a broker. So there are a lot of different steps, but it's the way that - You're going through a broker that's probably buying and selling through Virtu or Citadel. Sure. Something like that. But it's the way the security slots are set up. You already have that inherent contract built into it today. Yeah. Okay. So let me ask you this about what that implies for the ecosystem going forward. And then we'll talk about what FIT21 does.

8:24But under this current ruling from Judge Torres, What does that mean about the way that these tokens and other tokens that may or may not be similar to XRP will be treated if you have this circumstance where the underlying tokens themselves are not a security but the manner of sale was deemed to be? I think it's an important distinction to make, and it really is something that people should be mindful of moving forward. However, this is a district court decision. Now, it's a district court decision from one of the most important districts in the country. The Southern District of New York is sort of very powerful and well regarded throughout the country in terms of the types of judicial decisions that come out, especially because so much financial services litigation comes through there.

9:06So I do think it's a very well respected place and the decision should be obviously well respected. But it's based on the facts that were in front of the court at the time. Can we extrapolate? sure, I think we do need to think about whether there are contracts and not just written contracts, but also implied contracts. You know, you said, oh, certain representations were made. And so I do think it's important. And this is something I, you know, in my little career, I've talked to software developers a lot about what you say publicly sticks with you. And so you really need to think about that going forward.

9:38And I do think that companies have become much more mindful of that generally. But I think the other thing, and it will fit into this idea of fit, is this is one district court. You can harmonize it with KIC and Telegram and Library and things like that, but it's hard because these are all fact-specific cases. And so it's sort of creating a patchwork that's not clear. And so that is really why we need this legislative framework that comes forward through Chair McHenry and Chair Thompson. Hey, everyone, we're going to take a quick pause and hear a word from our partners. We'll be right back.

10:16Yeah, facts and circumstances will always differ by case. But let me ask you this, and just about the procedural element of how this moves forward. I interviewed John Deaton, obviously a pretty well-known attorney in the crypto space, who was trying to explain this to me. And again, I'll understand this imperfectly, correct me where I'm wrong. But he essentially said that this essentially becomes a kind of precedent until an appellate process takes place. Now, this is where I get a little confused and I'd like your help. As I understood what he was saying, basically, there's a case that has to unfold here against Mr.

10:48Larson and Mr. Garlinghouse before you have the ability to appeal the decision. However, he said there is the potential for interlocutory appeal, which is essentially a different type of appeal that might have the ability to reverse this decision while that appellate process is taking place. Unpack all of this for me. I know I didn't explain it well. Tell me a little bit about what all that means. Okay, great. So the decision itself was a motion for summary judgment. The SEC said, judge, you can look here, all the facts, you can just decide. We don't have to show it to a jury. And Ripple said the same.

11:21No, the facts support our reading of it. You still don't need to show it to a jury. And it's actually pretty rare, especially with a big record, like we know was developed here for a judge to be able to make a decision. So I do think she really focused on these transactions versus asset issue and move forward that way. To your point, though, there are a couple other claims that weren't resolved on this decision, the ones against Mr. Garlinghouse and Mr. Larson. Those are supposed to go to trial. And usually you cannot appeal in a case until the resolution of every single issue and every single claim in the case has come to an end.

11:58And that's when you do an appeal up to the Second Circuit. If there is a question that is of such great importance that you couldn't possibly go to trial until it was decided, then you can do what's called an interlocutory appeal. Usually that happens within 10 days after the decision has come out. You have to ask the district court if they'll certify it up to the Second Circuit for an interlocutory appeal. And the Second Circuit has to say they'll take it on interlocutory appeal, but the 10 days has passed already for the SEC to do that. So I'm not sure we'll see an interlocutory appeal. We may see what happens once the claims of it against the individuals are resolved.

12:35All right. So let me just ask you this. Is this 10-day filing deadline, a hard deadline for the interlocutory appeal, or can they appeal and specifically special circumstances warrant doing so? They could. They have to make a petition to Judge Torres to ask her to say it's okay that they appeal and to wait to go to trial on the individuals. I mean, I don't think it's a hard and fast 10 days, but it is a typical 10 days and it would be very strange to see it, but I could be proven wrong. You know, this SEC is very unpredictable sometimes. And how high is the threshold? Does this have to be something greater simply than we just don't like this decision, we don't like the outcome and we want to appeal it?

13:12It's got to have some sort of material reasons why this interlocutory appeal is being sought. I think it's basically the argument would be here is you couldn't possibly decide the questions against the individuals until we have a real resolution that we can rely on for the Second Circuit, because this doesn't really, you know, have precedential value, as you said. Other courts in the country don't have to look at the Ripple case when they're making decisions, and either other courts in the Southern District don't have to rely on Ripple. But once you have a decision at the Second Circuit level, that is precedential for all the lower courts in the Second Circuit.

13:48it. Excellent. Important facts. So let's talk a little bit now about the new legislation that's just made its way out of committee and how that would change the circumstances we find ourselves in today. In other words, if we found this case taking place after this had passed both houses and become law, what would be different? Nothing. That's the most amazing part. I mean, nothing is probably an overstatement, but the way that fit is set up looks very much like the outcome in the Ripple case, which I think is one of the most interesting things. And I was meeting with members of Congress and their staffers the day the Ripple decision came out.

14:25And one of the things I said is this is very consistent with the McHenry-Thompson bill, or FIT as we're calling it now. And it makes a lot of sense because of this assets versus transactions issue. But this is interesting. You're saying it looks like essentially nothing changes, meaning it's similar to what we saw after the decision in the Southern District of New York rather than before, which is interesting because presumably it started the committee process before the decision was made. So essentially what you're saying is that FIT now sets up a kind of a regulatory framework that actually looks like the decision we saw out of the Southern District.

14:59Yeah. If you think about it, the way that FIT works is if you have these private sales to insiders, usually what you would call these institutional investors where you have a contract, those become what are called restricted digital assets under FIT. And it's because it has this investment contract type construct in fit. And then it takes you through the decentralization process. And if you believe you can meet a number of the factors in fit for decentralization, then you go to the SEC and you ask for certification to be no longer a restricted digital asset and then a digital commodity. And you do still trade on venues, but it's not overseen by the SEC.

15:38It's overseen by the CFTC once you become a digital commodity. And ultimately, how would that change what the process is like in the United States for people who are in this business? You'd have a lot of clarity, right? I mean, I don't love this idea where we keep saying there's no regulatory clarity. But what I really want in the United States is for people to be able to just get back to the business of running their business. And I think that's what a lot of the large and small crypto companies want to do. I think there are actually a lot of software developers in the crypto space who wish they could set up here and who are making the decision not to.

16:10And so I think this would allow people to just move forward in a way that's sensible and makes sense. I think, well, there are some high hurdles to jump over for a number of the trading venues. There's under FIT, there is a provisional registration time while the SEC and the CFTC are making rules jointly for these different types of trading venues. So that's supposed to happen within the year after FIT is enacted. And so I think that there will be some time where people are working things out, but there will at least not be this ongoing fear that I think a lot of people in this space have been living with in terms of how their business will fare in the US.

16:46Let me ask you one more question about the XRP ruling. In some ways, it reminds me, and I'm just trying to get a sense of how it's similar to and how it's different from what happened with EOS. This is a case that's an interesting one because I believe it was the largest ICO in history, raising somewhere over$4 billion, I believe. They ultimately paid a fine in a settlement with SEC for, I think,$24 million. So 4 ,000 over 24, it's roughly like 1 160th of it. A relatively small fine, again, about the manner of sale of the security or what SEC deemed to be a security. What's the sort of the context for this?

17:24How does XRP relate to what we saw in EOS or not? There is no question about the ICOs that we were dealing with in 2017, 2018. And we've seen a lot of, as you said, these enforcement actions, including settlements. This was a very different transaction by transaction type of decision, mostly dealing with, as you said, institutional sales, programmatic sales, which are the sort of blind sales. And then two other types of transactions, one of which was giving tokens to individuals, and the other was these token grant programs that a lot of large L1s and L2s and other types of infrastructure providers and any of these software providers do with their tokens.

18:03By the way, those category of sales also did not constitute securities transactions for a number of different reasons under the decision. So EOS, though, looks much more like the institutional insider type of sale that XRP was looking at. It's just it was done on such a wide retail scale, really, with the ICOs. Yeah, interesting. By the way, now is a good time to call out to our viewers. Put down your questions in the chat. We're asking the best ones on the air. Remember, Real Vision members take priorities. But the good news is, if you're not a member yet, go to realvision.com forward slash crypto to sign up.

18:42That's realvision.com forward slash crypto. It is, of course, free. And it's where our new episodes of Ralph Powell's Adventures in Crypto air every Friday. Looks like our first question has come in. This one's from Ralph. And the question to you, Rebecca, is what are the odds that SEC enters into a memorandum of understanding with the CFTC on tokens to voluntarily share oversight of tokens with the CFTC like they have done with securities futures products? Obviously, a very sophisticated question there. Very sophisticated. I think to see the SEC and the CFTC voluntarily come together absent a strong legislative framework seems unlikely, just given that there has been sort of this divide.

19:27I think both Chair Benham of the CFTC and Chair Gensler of the SEC believe that there needs to be regulation of this space. They've both been very vocal about it. They've both approached it in similar and different ways. And so I think it'll be really hard to be able to parse apart what type of jurisdiction the SEC and the CFTC will have over the industry absent legislation. So what's the relationship between these two regulatory agencies? And to what extent does it depend on the personal relationship between the individuals who are running them at any given time? Great question. So these are both financial markets regulators in the United States.

20:05The SEC oversees securities. their mandate is really investor protection more than anything. The CFTC oversees the derivatives of the futures market, not just commodities, as it says, because there are plenty of commodities that are sold on the spot market. And the CFTC only has what's called anti-fraud authority over the spot market. So the reason that you need legislation is when you're doing these secondary sales of tokens, many of which people are arguing are commodities, you actually don't have CFTC jurisdiction over them. So will the personal relationship really bring these together? I don't know.

20:41There are definitely former chairs of the CFTC and the SEC who've been working together. Former CFTC chair Tim Massad and former SEC chair Jay Clayton have been doing a lot of work about how to regulate the space together. They've put out a lot of editorials in the Wall Street Journal and other large publications about it. But I don't think it's a relationship issue. I really think We need legislation to parse apart who and how is going to be overseeing these different parts of these new financial markets. It is sort of an unusual circumstance that we have here in the United States with sort of multiple competing regulators, not just CFTC and SEC, but also, you know, I mean, it's just an alphabet soup, right?

21:19The Fed, FINRA, OCC. I mean, they're just this incredible amount. And this, by the way, this isn't the way this works all over the rest of the developed world. In the UK, you've got the FCA, the Financial Conduct Authority. It's a single regulatory body controls everything. I guess there are benefits and disadvantages to doing it that way. But this is a system we have. Yeah, I mean, look, I think we have one of, if not the most developed financial markets in the world. And so I do think that that's how it's developed where we are today. I think the other piece of it is we have put in regulation and regulators in place to react to the way the financial markets were built out over time.

21:58And to your point, I mean, obviously, London or the UK has a very big financial market, but it's not at the same scale of import on a day-to-day basis. Hey, everyone, we're going to take another quick break and hear a word from our partners. We'll be right back to the Real Vision Crypto Daily Briefing.

22:19So let's talk a little bit about what you guys are doing at Polygon. Tell me about the Value Prop project. Sure. The Value Prop is an interactive database. base. It was really born from this issue. The thing that really pushed me forward is the president's economic report a few months ago, where he had a whole chapter on digital assets. And the end of it, it said crypto has absolutely no fundamental value. And I had been hearing from regulators and even you hear a lot just publicly, including from, you know, actors and other famous people at this point, like there's no value proposition. There's nothing that we actually need this technology for.

22:54And I've been in the space for a very long time. I've seen it be built out, not just in a financial way, but in lots of other exciting ways. And so I said, okay, well, let's go on the project of just pulling some of these together because when I'm speaking to regulators or policymakers all over the world, I want to be able to have something. And we saw that it was just sort of fragmented. There was nothing great where you could just pull it together and show somebody. And so we went through the process of calling a lot of applications, really trying to define what use cases were out there, and then crowdsourcing a lot of them too.

23:25It is a chain agnostic site. It's the value prop.io. You can see things on XRP ledger, on Bitcoin, on Ethereum. So anything that's really been built out. And after we launched it in early June, we had such an overwhelming response that we added well over a hundred applications to it. So you're now, you know, approaching about 450. And I think it's really given people a very strong aha moment to say how this has really been, you know, blockchain technology has been built out over time. You know, it's interesting you mentioned the president's report and the perception about what the United States is doing on this in terms of global leadership.

24:07Obviously, the Web 1 architecture was built almost exclusively in the United States. The United States has done very well based on what's happened and the innovation that's happened from Web 2. And now the open question about where we're going to land on this in Web 3, which brings us to our next question from Peter on Real Vision website. Do you see all of this, I guess this conversation that we're having, potentially driving blockchain away from the United States? How much of a risk is that in your view? The value prop is really meant to sort of combat anything like that. And I do actually think FIT and things like Ripple will sort of turn the tide a little bit.