Part 2 of CCN’s Interview with Caitlin Long
CCN: The entire [framework of] regulation is just a mystery to me at this point. There are so many things that are obvious that you think makes sense that just aren’t out there as far as protections go. I think we saw a lot of that in 2008 where you had these retail investors saying, “I had this much money, what happened?” I think there was a case where you had a savings bank losing hundreds of thousands of dollars with Lehman Brothers, that wasn’t guaranteed because I think they were a citizen of Hong Kong.
CL: I was reading an IMF paper. Sad enough just on that basis, they were talking about the Lehman situation and in the meltdown in both Lehman and also in MF Global. Though that particular one wasn’t referred to in this IMF paper, they said that Lehman did not acknowledge the firewalls that we’re supposed to have firewalls of client assets. This is an issue for me, personally, that’s a fear that I had when you’ve got a brokerage firm that’s going under like Lehman was, like MF Global was, even though those client assets are supposed to be ring-fenced.
Well, guess what, when John Corzine the CEO of MF Global is trying to save the firm, he’s got a heck of an incentive to ignore those ring fences. Those ring fences are not a literal firewall. Those ring fences are just those assets that are sitting in a separate account, and people can go to jail if they dip into those clients separate accounts. Did John Corzine go to jail? So there you have it. There’s an awful lot of moral hazard when it comes to segregation of assets. Unless the assets are segregated on an open blockchain where it’s transparent, and you can see that they’ve not been messed with, then you can’t trust that your assets are truly being custodied in the manner in which they should.
CCN: Do you see blockchain being used as a custodian’s tool across every type of asset class?
CL: Yes, and in fact, that’s one of the things that I did say that was positive about the bad news that they [Bakkt] lept right over the “blockchain, not bitcoin” intermediate step that so many other firms are doing right now, which is, essentially, “Well, let’s not go all the way to natively digital assets. Let’s just try to tokenize, to try to improve and cut costs and all this duplication and reconciliation of information that we have to do among all the different counterparties on Wall Street. Maybe there’s a way that we can share a ledger for a toke; we don’t need to go completely open blockchain because we do kind of trust each other. So let’s do these private walled garden-type blockchains.”
In fact, actually, when ICE [Intercontinental Exchange] came out and said they were embracing bitcoin, that was a game changer for me because that is a natively-digital asset. It’s not a tokenized asset but natively digital. It never existed in anything other than native form at its genesis moment. It only ever existed on the blockchain, and it never leaves the blockchain, only its ownership changes. So that is a game changer. I think that ICE could be tremendously successful if it were to adopt that as a strategy as opposed to trying to sort of mess with bitcoin if you will and try to rehypothecate and commingle it.
Instead of trying to do that let’s go out and get natively-digital securities. As a stock exchange, ICE could be a real leader if they said, “Let’s forget this crazy structure where there’s one global security sitting in a vault at the DTCC for all of the Apple shares outstanding and let’s instead start actually issuing these things natively digital and allocated them out to their rightful owners.” So you don’t have any of this commingling and rehypothecation without explicit consent from the owners of the securities. I’d love to see that, and that would be a huge positive relative to where we are today.
CCN: But do you really think ICE is going to do that? I mean do they have incentive to?
CL: I sure hope so. As critical as I’ve been of ICE over the rehypothecation of bitcoin, I’ve been very complimentary of ICE as an institution. The CEO, Jeff Sprecher, is one of the most respected people on Wall Street and some people would say he saved in New York Stock Exchange. He’s the guy who engineered the digitization of equities markets in U.S. digital trading more than anyone else. That saved a lot of people’s money. Yes, are there are downsides to it because you’ve got things like high-frequency trading and all the manipulation that comes with that.
It created problems like anything else new would. Of course, we all know bitcoin has its own problems, too. But is it a solution to this overarching problem, which is that Wall Street doesn’t keep accurate track of who owns what and ends up always issuing more securities than are legally upstanding because the ledger systems can’t keep track. Yeah, and to me, that’s a huge problem. And I would rather see that solved and take on the new problems that they’re having natively-digital bearer assets involved than trying to sort of build a system, which is what we’ve been doing for the last 40 years.
CCN: One of the interesting things I found about ICE, in general, is…Sprecher’s background, he really comes out of [the] instant settlement market with…energy policy. I mean, they were competing directly with Enron.
CL: Yeah, I knew that that’s how we got to start with electricity trading, but I didn’t realize that that was instant settlement. I don’t know if it is or not, I just don’t know how that market works.
CCN: Okay, I think that’s going to heavily influence his thoughts going forward. Like you said in the beginning of this interview, your background is heavily going to influence what you do. I’d be really interested to see how that energy market is regulated and settled to try to see what Ice is planning here.
CL: Certainly that market became a lot less manipulated after Enron, and the CFTC moved in and regulated it to a much greater degree, but I’m just not familiar with it. I’ve never personally traded or done anything in that market, so just not qualified to speak about it. But your point is well taken. That’s where he came from, and he basically acquired a whole series of key infrastructure players in U.S. markets and global markets. He owns what may be the largest clearinghouse in Europe. This is a global giant in market infrastructure; it is literally too big to fail. I say that both in the positive and negative context that that means because one of the things that I wrote about in the last article on Forbes.com about rehypothecation and commingling is the financial regulation used to try to disperse credit risk around the banking system.
I’m thinking that it was really going to be pretty rare for the entire banking system to incur a run. So as long as all the credit risk was dispersed, widely distributed, widely decentralized way to use some of the crypto phrases that was the safest way to deal with credit risk. We’ve essentially centralized it, post-financial crisis, it’s centralized in organizations such as ICE and these things are literally too big to fail, and the rehypothecation of collateral is a means by which all of these organizations can look like they’re more solvent than they really are. The problem is that because of the way how repo accounting works, you have multiple parties recording that they own the same asset at the same time. That is the way U.S. GAAP accounting requires the accounting for repo transactions to work.
Consequently, it looks like both financial institutions are solvent because they both are reporting that they own the asset, but there’s really only one asset. In a normal functioning market, if nobody actually wants to go claim their asset, then its fine, but if you get runs on the system, that’s when you realize just how insolvent the system is. I would give hats off to CFTC regulator Christopher Giancarlo. He’s been talking about this for years, and he’s right that the regulators don’t have a way to back out [of] all that double and triple and quadruple, quintuple counting of assets to know just how solvent the system as a whole really is.
CCN: I want to hear a little bit about how you really took Wyoming and turned it into this “Crypto Valley” that’s now really competing with incumbent giant Delaware.
CL: Thank you. I grew up there in Wyoming, that’s the nexus and has stayed very close. I have served on charitable boards there for years, and I just knew that this was an alignment of interest between Wyoming wanting to bring software companies into the state. It also had one of the worst laws for bitcoin and once we got the ball rolling to fix that bitcoin law (specifically it was the money transmitter law that essentially required the Coinbases and Circles of the world to have to leave the state into 2015. We set out to fix that, and we ended up doing that and a lot more, and there’s going to be more to come and I think — stay tuned — we actually have another task force meeting in September where we’ll work on legislation that’s going to be introduced in the next legislative session in early 2019 and we’re not done, there’s more going to be happening to support this industry in Wyoming and bring more companies into the state.
CCN: What do you think has been the most important as far as making Wyoming this crypto valley?
CL: Candidly, I actually think it’s the one that exempts crypto from property taxes. There’s no income tax in Wyoming, and there’s virtually no sales tax, virtually no property tax, it’s the lowest taxed state in the country and by coming out and saying that, given that there’s already no income tax, there also is no property tax. It’s very tax friendly. That’s meaningful.
Secondly, there is probably the one that got more attention, which is the utility token bill. That has run into the issues at the federal level, which is that everybody’s afraid of the SEC and running afoul of the SEC. What we’ve unfortunately seen is that more businesses have elected to go outside of the United States and domiciled their start-ups in places like Singapore, or Japan, or Malta, or Switzerland, or Gibraltar, then businesses that are taking the SEC risk and staying in Wyoming. That has definitely blocked the degree of success that we were hoping for in Wyoming, at least in the short term.
CCN: What federal regulation would you like to see for the U.S. to compete with these places like Malta that are very cryptocurrency and blockchain-friendly?
CL: I actually think what we did in Wyoming would be great. It is to say, we’re not going to change the securities laws, although there are several of those that need to be changed, but let’s acknowledge that certain things like airline points and gift cards and loyalty rewards programs can be traded in secondary markets and they’re not necessarily securities. If they’re not securities because they meet the criteria that we put in the Wyoming bill for not being securities in the State of Wyoming, then they are not going to be regulated by the SEC. The SEC has sort of played both sides there because they’ve come out originally and said that everything they’ve seen so far was a security. That comment just caused the entire industry to seize and frankly flee offshore. They walked it back since then, I think, in part because they saw just how many American businesses were actually fleeing offshore as a result.
I would like to see that. I’ve also suggested I’d like to see them do away with the requirement that if an open blockchain is used to custody an asset that setting up a requiring a qualified custodian for that asset, [which] actually introduces risk where those risks wouldn’t otherwise exist. A qualified custodian is like a pension funds custodian. We’ve been talking about them earlier in the in the interview, and the gist is that large investment adviser should manage more than $150 million or required to segregate their assets and hold them in a third-party custodian. The problem with that is, of course, if you’re having somebody hold digital assets in a third party, we’re back to the Andreas [Antonopoulos] point, “not your keys, not your bitcoin.” You can use multi-sig, you can use time locks, there’s a lot that you can use, but none of them is recognized under current qualified custodial laws. I actually think that that’s probably the most important change the SEC needs to make to support the industry, is take that old law, it’s outdated for this technology. If we’re talking about digital bearer assets, don’t introduce risk where otherwise doesn’t exist.
CCN: I think that makes a ton of sense there. Coming back to Wyoming, I’m curious about your perspective on New York’s Department of Financial Services actions over the past four or five years regarding blockchain, what they did right, what they did wrong, with your experience in that market.
CL: Way too heavy-handed. Wyoming took the approach of “let’s create enabling legislation rather than restrictive legislation.” New York did the opposite. New York said, let’s restrict, let’s not enable. It was arrogance frankly, that they thought everybody would want to be in New York, but a lot of the big players essentially just avoided New York. You saw Jesse Powell of Kraken talked very publicly about that. He’s just not in New York because he’s not doing business in New York; they have no jurisdiction over him. I agree with Jesse. I think New York — it’s acknowledged in the industry — that they went way too far and that needs to be rolled back.
CCN: The regulations there are just insane. And the cost to acquire a crypto license is beyond what a lot of these smaller startups can handle.
CL: Yes, that’s right. It’s unfair. It’s part of the thing that sends these smaller start-ups offshore. Once they’re gone offshore, the interesting question is, will they ever come back?
CCN: Do they really have any incentive to come back?
CL: Right. Once they’ve set up offshore, they incur costs to come back onshore. They’ll only come back onshore if it’s in their interest, but when we can capture businesses and have them set up in a local jurisdiction, and they have no switching costs, is that their genesis moment and that’s why again, Wyoming is going after this so hard, and I sure wish that the SEC would just clarify things. I think a lot of people are interested in just clarifying the rules and if we get clarity on the rules, then it gives lawyers the ability to advise clients saying yes that they can stay in the United States without risk of literally going to jail. Right now, there’s too much risk, and most lawyers are advising their customers to leave and go offshore.
CCN: Last question here. Up until this point in this podcast, we’ve pretty much just interviewed cryptocurrency founders. One of the questions I love to ask them is where you see your company in five years? I’m curious where you see this entire industry in five years, and in particular, how Wyoming fits into that?
CL: I think Wyoming is going to be the Delaware of this industry. I think a lot of companies are going to domicile there and existing businesses are already re-domiciling there in part for the tax and regulatory clarity. I think Wyoming is going to be the Delaware of the crypto industry. Where will the crypto industry be? I’m very convinced that money is going to be digital open blockchain tokens, i.e. bitcoin. It may not look like bitcoin today, because it’s going to over the next 20 years evolve substantially, but I do believe that it is such a superior system and it’s fairer to regular folks, especially folks [that] have limited means. It’s so much fairer than the system that we have today and that we will end up transitioning over to that how smooth that transition is going to be, is an open question. It all depends on whether the powers that be in the existing financial industry recognize that this is the direction that it’s heading. I will compliment ICE for recognizing that and being the first of the big mainstream institutions to dip their toes into natively-digital assets. This is just a much more superior system. Let’s keep that ball rolling.