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Free Markets vs. Investor Protections: The Latest From Warren and Gensler on Crypto

Gensler testified before the Senate yesterday. This is what we learned.

Listen on:

On this episode

This episode is sponsored by NYDIG.

Today on “The Breakdown,” NLW examines SEC Chair Gary Gensler’s testimony yesterday in front of the Senate Banking Committee. He discusses:

  • How some allies from the infrastructure bill put the screws to Gensler on lack of clarity around securities designation
  • How Gensler is trying to redefine stablecoins
  • Warren and Gensler’s dubious understanding of ETH fees
  • The central problem of free markets vs. investor protections

NLW also covers the Solana outage and the reports of insider trading at OpenSea.

“The Breakdown” is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Only in Time” by Abloom. Image credit: Andrew Harrer/Bloomberg/Getty Images, modified by CoinDesk.

Transcript

What’s going on guys, it is Wednesday, September 15. And I have a feeling this one might get a little spicy.

You just heard Ray Dalio speaking yesterday with Andrew Ross Sorkin. Now, I start with that for a few reasons. We already knew that Dalio held bitcoin, that was revealed in the lead-up to the Consensus conference this year that he keynoted. Plus, it’s been clear that he’s been flirting with it for a while. Second, though, I think there was something interesting in how he described “why bitcoin.” First, his assertion that any alternative to cash makes sense right now, that’s a telling macro signal; but second, this idea of how far it had come. This is the “Bitcoin Lindy” argument, the argument that the longer Bitcoin survives, the more it attracts people because they can’t ignore it any longer. Third, I genuinely think that skeptical but in-the-money bitcoin Ray Dalio is a bigger draw to the space than would be a laser-eyed, “all guns blazing” bitcoin Dalio. The reason is that at this point, a lot of the macro guys who aren’t in already, are long term holdouts, they have their own sets of skepticisms and questions, which whether we find them convincing or not, shape their decisions, having a cautious skeptic who still has questions, but who says anyways that he’s invested, is likely, to that set of folks, more compelling than just another Manic Street preacher like the rest of us, right? Finally, though, the reason that I shared that clip is to set up today’s show. This idea that if it gets big, governments aren’t going to like it.

Yesterday, SEC Chair Gary Gensler testified before the Senate Banking Committee. Today’s show’s main topic is that testimony and how to make sense of it. I joked this morning that I’m so sick of covering Gensler and Warren on crypto, and it’s only barely begun, add Yellen to that mix and you really have one of the power axes that we’re going to have to spend at least the next three and a half years battling with, it seems. Anyway, we’ll get into that in just a minute. But first, I wanted to make a brief mention of two other things that happened yesterday, which may be worth revisiting in a more complete capacity later. The first is Solana of going down for something like 20 hours, and the TLDR on what happened is that there was an outage that began early Tuesday after “resource exhaustion brought validation to a halt.” The explanation, proffered by CEO Anatoly Yakovenko, was too many transactions: “Looks like a similar resource exhaustion as to a week ago. Which is a forwarder queue flood. 2/3 of those fixes where just tagged in 1.6.23 release. Just needed a few days to soak them before release.” He then later said “Bots during a raydium ido are flooding the network at 300k txs per second. The queues that forwards txs to block producers grew in size to a point that caused excessive forking.  The fix to prioritize messages in this queue was already in the works but wasn’t out yet.” So, the network is now back online, but those specifics aren’t really what I wanted to mention.

I wanted to point out that effectively, this has served as a Rorschach test on Ethereum and Ethereum alternatives. Solana folks were quick to point to its status as a beta product, or how early in the network’s life it was, or comparable outages early in its life or, frankly, to just it’s insane price gain. So who cares? The Ethereum community, who have been really, really responding negatively recently towards the swirl of excitement around Solana, went for the absolute juggler, just savaging the product all day. The particular thing, of course, was them making fun of the supposed decentralization of Solana: “quick, call the CEO” they said, or they made jokes about how if you can get all the validators in a single discord, it’s not decentralized. A couple of things. One, look, if your network goes down, you’re going to get dunked. Solana’s team clearly knew that and just kept plugging along without being too drawn in, which I think is good. Two, much-ballyhooed Layer 2 Ethereum scaling solution Arbitrum also went down, admittedly for not as long, but seriously, there was stuff going around everywhere.

Third, though, and most importantly, I think the conversation about decentralization is a lot more nuanced than some folks are making it. Bitcoin has made the clearest prioritization around the trade-offs of massive, unimpeachable decentralization. If you’re not going to go that far, right, if that’s one extreme and traditional centralized companies or on the other, what are the gradations in the middle? What are the important lines, and why? I’m not saying there aren’t answers to that, but that’s the conversation that is begging to be had. And, I think there might be a fair few folks who come out with different answers than one another, and will have different chains to service those perspectives. An interesting micro version of this conversation came up, Spencer Noon tweeted: “The reality with this Solana outage is that it’s perfectly normal for an up-and-coming chain to go through this. It will be back soon and better for it, but I feel bad for users who need the chain to do real things who were misled to believe it was as reliable, or better than, ETH.” Anatoly responded: “‘Better than’ still stand by it. When fees go above what the user is willing to pay for access, it’s 100% a network failure to that user.” For what it’s worth, some pointed to a Vitalik tweet from years ago where he basically said that big fees should be treated as live-ness failures. Spencer responded: “I hear you and that’s an awesome debate topic.” And to that, I agree.

Moving on from that though, let’s talk OpenSea. This is one that I really want to get a little bit more info on, but I do think is germane to our main topic as well. OpenSea is, of course, the biggest NFT exchange marketplace, etc out there. It had more than $3 billion in volume last month. Yesterday evening, @ZuwuTV tweeted: “Hey OpenSea why does it appear Nate Chastain has a few secret wallets that appears to buy your front page drops before they are listed, then sells them shortly after the front-page-hype spike for profits, and then tumbles them back to his main wallet with his punk on it?” So in question is Nate Chastain, a product manager at OpenSea, who is being accused here of front-running the market based on information that he uniquely has, because of OpenSea itself. Ten thousand likes later, and this is a friggin story. Other people went and started Sherlock-ing the whole thing, pointing out some 10 transactions where Nate appeared to be front-running the community. His defenders said that we didn’t really have timestamps on when the front page placement went live, so it was all sort of specious.

But, then about 13 hours after the initial tweet this morning, OpenSea released this statement: “Yesterday, we learned that one of our employees purchased items that they knew were set to display on our front page before they appeared there publicly. This is incredibly disappointing, we want to be clear that this behavior does not represent our values as a team. We’re taking this very seriously and are conducting an immediate and thorough review of this incident so that we have a full understanding of the facts and additional steps we need to take. We’ve also implemented the following policies: OpenSea members may not buy or sell from collections or creators while we are featuring or promoting them, e.g. on our homepage. And, OpenSea team members are prohibited from using confidential information to purchase or sell any NFTs, whether available on the OpenSea platform, or not. For a new, more open internet that empowers creators and collectors, we will need to bake in trust and transparency into all we do. We’re committed to doing the right thing for our users and earning back the trust of the community that we serve.”

Now, like I said, a day later, there are a few people who are defending Nate: Mike Dudas of Paxos, formerly of The Block, tweeted that he’s a good person and a great product manager, and cares seriously about the customers. Beanie Maxie says: “Funny to see the hypocrites that got rich JPEG trading through a guy that helped make them rich under the bus over an ‘insider trading allegation.’ Nate Chastain has done so much for OpenSea, he works 24/7 too. I also know the same haters would trade on the same info without blinking.” Boy, I gotta say though, are these two in the minority. I think it’s very dicey to publicly call for disciplinary actions or any type of actions around this, and I certainly don’t have all the information, but I will say this, if this is what it looks like, it’s f**king insider trading.

As I mentioned yesterday, Gensler testified before the Senate Banking Committee. His prepared testimony came out first, it came out the evening before, and there’s really not much new in there. He says a lot of the same things that he’s been saying before. If anything, the tone is getting a little bit more aggressive, but really none of it’s new. The two things that I think worth pointing out are one, a lot of people have been giving a bit of a stank face to the line “I’ve suggested the platforms and projects come in and talk to us.” Based on what we saw with Coinbase last week, that doesn’t really seem to be getting projects anywhere. Indeed if “come in and talk to us” means “come in and hear us yell ‘Howey’ at you for an hour or two,’” it just doesn’t strike me as something that many are going to get a lot of value from. The other thing that some astute observers noted was Gensler’s use of a term that literally has never been used before: “stable value coins” in place of “stablecoins.” Caitlin Long wrote: “GARY GENSLER testimony in front of Senate Banking tomorrow is out. Tone is negative--more so than his previous remarks. Something else interesting--instead of #stablecoins he’s calling them “stable value coins.” Stable value funds are SEC-regulated so...” Congressman Tom Emmer also very much picked up on the same thing, saying: “Is Gary Gensler actually attempting to assume authority over stablecoins by rebranding them stable value coins?”

The ethics of insider trading aren’t some quaint artifact of legacy finance that we should get rid of. They are a fundamental pillar of functioning free markets. The free and free markets is about certain equanimity and privileged information is one of those things that can, and will, absolutely undermine the functioning of free markets. Look, as you’re about to see, and if you’re not aware, we are fighting for a new type of finance that isn’t completely surrounded by paternalistic regulations, because we believe in free markets and we think we can create fair market access. Insider trading completely, and I mean, completely, undermines that argument, which I guess gets us to our main topic.

What about what happened in the actual testimony? Well, some of our friends from the infrastructure bill process showed up again, Pat Toomey from Pennsylvania blasted Gensler for not providing clear guidelines. He said: “I understand that SEC staff will privately provide feedback and analysis on whether a cryptocurrency is a security. Why keep this analysis private? Why not publicly announce what characteristics make a cryptocurrency a security or not a security? Why wait to make the SEC views known only when it swoops in with an enforcement action, in some cases, years after the product was launched? This regulation by enforcement is extremely objectionable, and it will kill domestic innovation.” He also asked specifically about stablecoins, to which Gensler demurred, saying a line that pretty much sums up his life at this point: “They may well be securities.” Toomey responded: “To me, a stablecoin doesn’t meet the second prong of the Howey test that there has to be an expectation of profits from the investment. If it doesn’t meet the Howey test, it looks to me like it’s not a security. Now, maybe you’ve got a good argument for why some are and some aren’t. But, I think we need to have clarity on this. I think we ought to have that publicly and we certainly shouldn’t be taking enforcement action against somebody without having provided that clarity.”

And then, oh, boy, oh, boy. It was Elizabeth Warren’s turn. She starts: “We hear a lot about how crypto is all about financial inclusion. I want to test out with you if crypto is an improvement over the financial system.” From there, she chose the example of last week’s crash, which obviously we covered on the show. “In a matter of hours,” she said, “$400 billion in market value just disappeared.” And here’s where we get to the realm of the theoretical. “Imagine,” she asked, “a hypothetical retail investor, who just happens to fire up Coinbase on Monday night and buys up a hot bag of Solana or something, right? On Tuesday, the market goes down. The investor tries to get to Coinbase, only to find their site down. That person couldn’t complain to anyone,” Warren decried, “because of course, there’s no federal regulatory regime for exchanges.” At this point, by the way, Gensler uses this opportunity to call out Coinbase for not registering as a Securities Exchange. Then, Warren kept going and talking about DeFi exchanges, (her term,) “Well, those wouldn’t work either, even though they were up the whole time,” because “the fee to swap between two tokens on the Ethereum network last Tuesday was more than $500.” And here’s where the Twitter memesters just went absolutely nuts. Adam Cochran pointed out: “When Senator Warren asked Gensler about high ethereum fees on decentralized exchanges, and if he knew what the fees would have been like on the crash last Tuesday, he replied: ‘Whatever the exchange has outlined in their user agreement,’ not gas, not code, user agreement. When he was researching crypto and decentralized systems at MIT, I think it’s safe to say he didn’t really touch on solidity and smart contracts. This is why crypto needs self regulating bodies or a seat at the table. Regulators need to understand what they regulate.”

I mean, this is very egregious. If he is making DeFi a central pillar of his problem, and he doesn’t understand that fees on a decentralized exchange are going to be set by a market, not something that’s outlined in a user agreement, we have serious problems. But I think that’s actually incidental to the larger issue, which is that these regulators live in a paradigm in which there can be no such thing as free and open markets regulated by math, rules and transparency. They simply don’t understand this as a possibility. Cochran shared another snippet of a recent Gensler interview that gets to the same thing. After being asked the question ‘is the decentralization of crypto, or the decentralization that crypto aspires to, inherently in conflict with the SEC’s mission to regulate?’ Ginzer said: “There’s a range of market structures that can work, but they work best when they’re in some sort of regulatory perimeter. I happen to think a lot of economics shows that transparency works better for investors and issuers than darkness. Central clearing can lower the risks of the market and enhance competition in many cases. When you say decentralization, markets over centuries tend towards some centralization. In antiquity, you’d bring the apples, or rice, or grains into the central market square. It’s where the wholesalers met and haggled. I don’t think it’s a surprise that that’s where you get the most transparency.”

Cochran writes: “This snippet explains the fundamental gap between Gensler and crypto right now, his view is centralized clearing houses can ensure transparency to lower risk, rather than realizing that can all be better achieved just by displaying on-chain data.” Another statement from committee chair Sherrod Brown that I think is revealing: “Many have been enticed by dramatic jumps in the value of new digital assets. Some professional investors and celebrities make earning millions look easy. But as we are reminded time and time again, it’s never that simple. Too often, someone’s quick profit comes at the expense of workers and entire communities.” As I said at the beginning, I’m sick of recording this podcast what feels like again, and again. I’m tremendously annoyed that Elizabeth Warren has decided to pick this fight as the next salvo in her career, and then I’m going to have to keep doing it.

But what I think it comes down to is this. Crypto is an archetypal free market. Perhaps the freest market on Earth at the moment, and has been for some time. With this ilk of regulator doesn’t get, or doesn’t respect, is that this type of free market doesn’t just stay wild. It sorts itself out in different ways than regulation, exchange downtime that they mentioned? People move to different exchanges that are better at not being down. Boom, free market solution. ETH fees too high? How about the absolute goddamn insurgency of Layer 1 competitors who are attracting a ton of attention and capital. Boom, free market solution! Insider trading at the big new NFT exchange? On-chain sleuths use the inherent transparency of the blockchain to uncover the bad behavior, and it gets addressed. Boom, free market solution.

Now, of course, the best critical response to what I just said is “Yeah, but what about recourse for the people who get hurt along the way?” I’ve three answers to that. The first is that when there are real, genuine scams that target and abuse vulnerable populations, absolutely go after that, although maybe, just maybe, patting yourself on the back for prosecuting BitConnect four years after the damage was done, isn’t really the most impressive indicator of your capacity for that. My second response is the harshest, but comes down to the absolute first thing that anyone learns about economics. There ain’t no such thing as a free lunch. We’re talking about taking risk. When you take risks to invest in markets, you’re taking risks. Risk is the only way there is value in the reward. The real, lived human reality of markets, by the way, is that the risk isn’t just the risk of number going down. It’s counterparty risk on exchanges. It’s bad behavior risk of humans, it’s sensationalist news risk of media, it’s political risk of grouchy former bank antagonists looking for their next political score. That is the reality. We can debate how much of these types of risks should be required, but to the person who bought on Monday and tried to panic sell on Tuesday and couldn’t? Well, if they’d waited about 48 hours instead of trying to get out the next day in some sort of insane short-termism, they would have been basically completely whole again, there is so much BS theory here where these politicians take these tiny moments and snapshots in time, rather than recognizing that over the course of the last decade, buying and holding crypto has been one of the most extraordinary opportunities that retail investors have ever had.

Which gets me to my third response, we need to be a lot more careful about who we view as someone who needs protection. In the Warren-Gensler mindset, anyone who is not an institutional investor needs to be protected. That may make sense to Gary who made $120 million off his time at Goldman and in other parts of the very, very walled gardens of traditional finance, but it simply isn’t the case, when “retail” spent the last decade kicking the ever-loving s**t out of institutional investors in one of the biggest wealth creation moments in history. Maybe we think a little bit before we lump all retail investors into some paternalistic bucket of little guys who need protection. In fact, it is the first time in history that this was possible because crypto’s permissionless nature inherently obliterates barriers to entry. In other words, the first time in history that retail investors weren’t structurally pushed out of denied access to an investment opportunity. They completely beat nearly every professional investor to it. I’ve said this before, and I’ll say it again. The crypto industry, by and large, is not opposed to regulation. It’s not even opposed to the right type of investor protection and counterparty de-risking. What it wants is for these regulators to, if they please, could put aside their evidence derision for us long enough to have an actual conversation. And, in so doing, perhaps, put aside their priors about who needs protecting just because they’re not rich yet. Until tomorrow, guys, be safe. Take care of each other, peace!

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