Blockchain Webinar Series | Exploring decentralized finance: Understanding the latest trends and legal developments

Usman: Okay. So I think we're going to get started as we have a full agenda. The number is going to continue to accumulate we have a pretty jammed pack session today and a lot of ground to cover. So thank you everyone for joining our webinar. On behalf of Gowling WLG let me welcome you to this session. It's called 'Exploring Decentralized Finance: Understanding the Latest Trends and Legal Considerations'. My name is Usman Sheikh and I'm the head of the Blockchain and Smart Contract group at our firm. Just by way of a little bit of background, our group has been immersed in the Blockchain space for about 4 to 5 years now. We have a team of around 30 to 40 lawyers who practice in this space and all different various areas. Whether it's capital markets or IP or litigation. We represent some of the co-founders in Ethereum, many banks, stock exchanges, crypto platforms, pioneers, startups in the area and we try to help educate regulators around the world as well. So whether it's addressing the Member States of the IMF or speaking with the RCMP or the Monetary Authority in Singapore, we have tried to impart some of our knowledge to regulators to help facilitate innovation in this area. Before diving into the session today I thought I would note that this webinar, in fact, is the fourth in a six part series of webinars that we've been having on some of the hottest topics in the area of Blockchain technology. The first session was on crypto asset trading platforms, also known as crypto exchanges. The second session was on non-fungible tokens or NFTs. The third was on Stablecoins and CBDCs, or Central Bank Digital Currencies. This session here today is, I mentioned, is on DeFi. The next is on intellectual property and open source and the last, but not least, is on Blockchain litigation. Whether it's civil, criminal or regulatory cases. So if you want to sign up for any of those future sessions you should feel free to click the link in the invite that you were provided or feel free to reach out to our website. Then you can also access these other webinars by looking at our Blockchain website on our Gowling page as well. I guess just before diving into the substance of today's topic, I should note that the session is eligible for 1 hour of substantive CPD credits with the Law Society of Ontario, British Columbia and Quebec and may be eligible for 1 hour of CPD or CLE credits in other jurisdictions. Then just another final note just before we get started, and of course because we are lawyers, we wanted to just highlight a key disclaimer. That is that this presentation is not intended as legal advice and is certainly in no way intended to give investment advice. So for specific legal advice on matters that affect you feel free, and you are strongly encouraged, to contact legal counsel and certainly for investment advice please contact your regulated and registered investment advisor. Okay, so with all of that out of the way, let me begin with a few introductions.

I'm really honoured, I have to say, and very privileged to be joined here today with such excellent talented guests on this panel relating to DeFi. I'll start with my own colleague, Michael Garellek. He's a partner in our Montreal office. He serves as the co-Leader of our Financial Services Regulatory group and he really helps with co-lead our most critical Blockchain mandates that our Blockchain group works on. We also have several external guests that I'm really thrilled and honoured to have with us today. We have Lee Schneider. He is a financial services and technology lawyer and I'd say one of the most respected lawyers in the US and, frankly, around the world on FinTech and Blockchain matters. He serves as General Counsel for Ava Labs, a leading Blockchain software company. In his spare time he also co-hosts a FinTech podcast with former FCC Commissioner, Troy Paredes, which is available on iTunes and other podcast services. Then equally weighty as an authority individual is Marc Boiron, who is General Counsel at dYdX Trading Inc. Before joining dYdX Marc was in private practice and he advised many of the top companies developing decentralized protocols on financing and regulatory matters. I've known Lee and Marc for quite a number of years and I've seen their excellent work with my own eyes. So I'm thrilled and honoured to have each of you here and thanks for joining.

So, if I can then, let me begin with some questions that I'm going to lob to our panelists. Let me begin with a quite basic but somewhat complex question out of the gate which is, what is DeFi and why is it important? Maybe, Lee, if we can start off with you.

Lee: Sure. Thank you, Usman, and thank you for those very kind words of introduction. As everybody on the call probably knows, you're also one of the best Blockchain lawyers in the world, so you should take your own bow for that. So thank you. So the definition of DeFi, like anything else that's new, there's lots of different people who are putting out lots of different types of definitions. I think sort of at its basic level, the way that I think about DeFi, is really just taking traditional financial services type offerings, breaking them down into their component parts and then replicating those component parts with computer code that becomes a smart contract on a decentralized Blockchain. That actually has really profound implications. One of the most profound implications is that anybody who has a computer and internet access can access the DeFi applications, smart contract, on the public Blockchain. That definition tells us a lot, but it doesn't tell us a lot about how we should think about the regulation of DeFi, and regulators are still grappling with their own definitions of DeFi with putting different types of DeFi smart contracts into different categories to think about how they would get regulated. I'm sure we'll talk more about all of those topics as the hour progresses.

Usman: Maybe if I could just press you, Lee, before moving to Marc, why is this movement, why is DeFi so important?

Lee: It depends on who you talk to. I think it's important for a couple of key reasons and several of them dovetail with the reasons I think that Blockchain and decentralization are important. I think it's important because, as I said, it allows anybody with computer and internet access to participate. A lot of the barriers to entry, so to speak, just aren't there. Without those barriers of entry you have really great economic inclusion, financial inclusion, whatever the terminology is that you want to use. I think another reason it's important is it's actually the culmination in many ways of a whole bunch of themes that we've seen in financial services, and in other businesses, with the rise of technology. Everything is becoming more automated. Everything has been becoming automated. Before I focused in the Blockchain world I did a lot in financial services in the brokerage space and you just watched over the course of 25 years how everything moved from paper to computers. When the floor brokers on the New York Stock Exchange got handhelds to do all their orders, that was a big day, and we just keep seeing these trends towards automation and those trends really culminate with Blockchain and decentralization and DeFi because now everything is automated. Your activities are completely automated. The computers are handling everything and you don't need intermediaries as a result of that which is another important trend that we'll talk about. I guess the last important thing to note is it's all about computer codes. So if a computer code is not functioning the way people intended for it to function then all kinds of bad things can happen and we do see problems with DeFi protocols. We've seem some problems with certain Stablecoin protocols where people hadn't quite thought through the implications of various exploits to the code, or exploits to the platform, and that resulted in great losses and other issues.

Usman: Right. We'll touch upon some of those points in a moment. Marc, maybe if I can turn to you and ask you the same question, how do you define DeFi and why, to you, are DeFi projects important?

Marc: Yeah, I mean I think Lee did a really good job of defining it. Maybe like a simple way of putting it is, essentially, a way of replacing traditional financial products with financial products that now exist on a Blockchain and those financial products could just be payments. It could be insurance. It could be lending and borrowing. A wide range of financial products that is now occurring in a kind of decentralized manner with no intermediaries. This gets to why it's I think it's important and interesting. Lee talked about the permissionless nature of it. Everybody can have access to it. I think that's very important. Another one is censorship resistance. I think in Canada and the US we view that as less important, maybe, than in other jurisdictions. But this idea that the DeFi protocols exist on decentralized networks, and unless you're going to be able to shutdown those decentralized networks, you're not going to be able to shutdown these DeFi protocols. That type of censorship resistance means that you've got people all over the world that have access to these financial products, and nobody can stop them from having access to them because nobody can take them down, and they're permissionless. Add on top of that what people refer to as composability of DeFi. Some people refer to it as money Legos. It's this idea that in traditional finance most financial products are going to be controlled or permissioned in some way. Whether it's from an IP perspective or just needing access to a database. Therefore if you want to integrate two products together it's take a lot of time, effort, expense. In DeFi you look at an open source code and you say, "I think that the open source code that I'm writing could interact well with that one and can leverage certain aspects of it." Might even be able to leverage that entire protocol and just plug into it. What you see is you see protocols that build one on top of another very quickly and efficiently and, again, without needing anybody's permission. Now that also creates risk. You can have one protocol that could have a bug, as Lee mentioned, on top of another protocol that could have a bug, on top of another protocol that could have a bug, that composability has risks along with it. But I think it also has significant benefits that can't really be ignored because of how efficient it makes things.

Usman: Yeah, an interesting definition that was offered by the World Economic Forum recently was that decentralized finance, or DeFi, is a broader term for financial services that really build on top of the decentralized foundations of Blockchain. Which I think is, to the extent that there's no standardization of terminology, is a helpful way of looking at it. Of late, I mean DeFi has been around for a little bit of time but we've seen it rise to the fore of attention, not only because of the size. We now have in terms of size as of, I think it was looking at DeFipost.com recently, and as of this month approximately about 55.1, or thereabouts, in billions of crypto assets are locked into these types of protocols. A lot of the projects that we've spoken to in the DeFi area have seen this as really the next step in Blockchain, correct me if I'm wrong and you may have a different view, to the extent that it's really realizing that vision that Satoshi Yakamoto, who offered this mysterious individual he, she or they, had of decentralization. So this is really taking it beyond what some people say is just the strict value transfer of moving one bitcoin from one individual to another. It's really opening up a whole new set of complex financial use cases as well. All the while disintermediating, meaning your moving your traditional intermediaries in those functions, and by extension therefore, at least the argument goes, is removing those significant costs and the needless delay and other things that can happen, whether it's fraud or bankruptcy risk, etcetera, etcetera, all through platforms that are based on code and technology. So for a lot of reasons we've seen these products, when they come to the fore, I guess those are some of the main reasons that we have seen. I don't know, Michael, if you wanted to add to any of that?

Michael: Certainly. I think even what we've seen together, Usman, is not just the scale to which DeFi protocols have accumulated participants and locked in funds but the speed also. I think we're aware of some projects how quickly they can grow. How quickly they can attract users and within a number of days, within a number of hours, a project can have billions of dollars associated with it. I think that is perhaps an area of concern for regulators and I think there's also a concern where when individuals act as their own financial service providers, the question sometimes we've heard from regulators is, are they equipped to manage the risks themselves in providing that service? Yes, it's to themself but does that open up risk to them?

Usman: Yeah, and we're going to touch upon on some of the regulatory reactions and developments in that space but maybe if I could turn back to our guests and maybe, Marc, if I could start off with you, what are some of the key projects, developments, trends that you've been seeing in the DeFi industry of late?

Marc: Yeah. I mean it's hard to define 'of late' in DeFi because it's almost weekly. But I think it's worth kind of going for just the basic, like some protocols that have existed for a while, like MakerDAo. Depending on how you define DeFi you could call them the grandfather of DeFi, and essentially it's a protocol that allows for the decentralized creation of a currency that is intended to remain tagged very closely to a fixed value, specifically a dollar. That's done with collateral that initially was just one cryptocurrency and now has expanded to many others. It's really kind of a foundation for a lot of others and what they've built. Partially because what you have is a permissionless and censorship resistant currency and when you have that, and it's stable, you can now use that in various other protocols. It serves as a good foundation for that. When you talk about other protocols what you see is borrowing, kind of supplying and borrowing pools where, effectively, people will pool cryptocurrencies and others can borrow against that. Nobody's involved in that transaction. There's a kind of supply and demand dynamic that determines the interest rate that gets paid. It's done in an over collateralized way so that money does not get lost in case the collateral drops in value and you don't repay your loan. What you see there is very high rates on things like Stablecoins, which drives a lot of interest in parties being able to get yield, that potentially they don't get in other places and ..., again, being kind of a key component in that with growing other Stablecoin interest such as USDC. Then from there what you see is spot markets in DeFi. Which really end up being core to DeFi in a similar way to Maker. The best example of this is something like Uniswap. Unlike your traditional order book, what Uniswap does, and you could refer to it as many do is an automated market maker. Essentially you pool assets and then you trade against that pool of assets. While that is not very efficient from a capital efficiency perspective it is pretty amazing when you start talking about long tail assets. When you look at Uniswap, and there are probably 30 thousand different assets that you can trade on Uniswap, or tiers that you can trade against on Uniswap, what you see is that some of the most eLiquid cryptocurrencies have a price. The question is just at what price can you trade it? Whereas typically, in finance, the question is can I even trade this? Can I find somebody? Once Uniswap comes along the answer's, I can always trade. It's just a question of what price can I do it at? Which is pretty game changing and ends up being core in terms of that composability when you need to exchange one cryptocurrency to another in another protocol. You can do but by just integrating into Uniswap. That allows you to do that. So I think those are some of the key projects that you'll see in this space. I think you see kind of evolutions that aren't as key but that kind of develop more products that aren't necessarily worth getting into in that sense. But in terms of continued developments, I think what you see is more complex DeFi protocols. They just continue to get more complex, as they use some of the ones that I mentioned as like base layers, you could say. I think the other thing is the things that don't deal with the protocol directly. Everything that happens around the protocol, I like to call it the 'social layer', and the social layer in a lot of these protocols are effectively because the protocols have governance tokens that are related to them. So these are tokens that allow you to control certain aspects of the protocol. If you're talking about like a borrowing and lending protocol it might allow you to change what assets can be part of it, maximum interest rates, floor of the interest rates, things of that nature that change just certain permissions within it. What you have there though is now a broad group of people that need to coordinate on how to do these things. People refer to them, in case it helps anyone, as DAOs, decentralized autonomous organizations, and definitely one of the trends here is a growing use of decentralized autonomous organizations. Some of them in very different forms from what I just described. Many in similar forms. The question is, how did those interact with the real world? If you look at the Uniswap protocol they have a treasury of Uni tokens that is controlled by governance. They can deploy, it's about 6 billion dollars worth of Uni right now, the question is how do they do that while interacting with the real world? That is a very difficult thing to figure out when there's not one set person or entity who is deciding how this gets governed. So that's some of the kind of background on DeFi and how kind of trends that are happening now.

Usman: Yup. Lee, what about yourself? I take Marc's point about what is of late mean but some recent developments, projects, trends that you've been seeing in the DeFi industry?

Lee: I think Marc mentioned some great examples and the idea of composability that he talked about is definitely one of the key things in DeFi. I sort of think of three other areas that are kind of cool in DeFi. One of them is sort of what I call a DeFi aggregators or dashports. So there's a bunch of projects right now that all they do is they present you with an interface so that you can see what's happening across all the different DeFi protocols that you are participating on. I am a very slight user of DeFi, mostly for experimentation purposes, and I will take issue with Marc's statement that you can trade anything on Uniswap because I did create metal and pool on Uniswap once and it never got one trade in the whole month that I had it up there. But it's probably because I chose two tokens that nobody else thought should be related but I thought should be related.

Usman: The swan token and the Gowling token is what you selected.

<laughter>

Usman: At zero trades.

Lee: Another trend that I think has been gathering steam is the yield farming trend and this takes also advantage of composability. These are protocols that actually look across a wide variety of DeFi projects to find out where you can get the best deal for different tokens that you might want to trade or stake or whatever. Using those protocols is kind of fun and interesting. The last area I would highlight is synthetics. Actually there's a product called Synthetix but I'm using it more in the colloquial sense of synthetic, synthetic assets and so this allows you to create synthetic returns on various assets. By the way, it can be both TradFi assets and Blockchain assets, so there's various levels of experimentation going on in that area which is probably giving a huge amount of heartburn to regulators all over the world.

Usman: It's interesting what we have been seeing within just the past few months are some really interesting developments in the DeFi space, of late. A lot of regulators are now focusing attention on this area and so, Lee, I know that you know Kevin Roebuck of, Professor Roebuck I should say, of Wharton who recently came out with, along with the World Economic Forum, a really helpful document called the 'The DeFi Policy Maker Toolkit' to help educate regulators in this space. We've been seeing a number of speeches being made, including most recently by CIPC Commissioner Dan Berkovitz, and then there's also legislative movements where Marc had referred to DAOs and, in fact, Wyoming came out with legislation relatively recently, I think it was signed into law in April but then took effect, I believe it was this month, on decentralized economists organization and giving them effectively some level of legal company status. Then in Canada as well, I thought what was interesting and, Michael, I know you and I have chatted about this, is that while simple digital assets, a crypto platform that has really received some exemptive relief to operate in Canada in the crypto space, began supporting several tokens relating to DeFi protocols. So I believe you had mentioned, I believe it was you Marc, ... and Uniswap and Compound, Curve, Dot Finance as well, these tokens are actually being supported, in fact, by that platform. Michael, I don't know if you had any thoughts on that in terms of trends? Oh, I think you're on mute.

Michael: From what we're seeing, yeah. Certainly where Canadian Securities Regulators now are putting a little more focus is on the crypto trading platforms. I think they're starting to turn attention to DeFi protocols and I'm not sure if we'll get into more of a discussion on that front and to what extent are they prepared to get there. But certainly that's one of the developments that we're seeing. Our clients are interested in interacting with the regulators and seeing how and to what extent the regulation will apply to them.

Usman: Right. So maybe let's move to a different topic. Sort of segueing from what you were saying, Michael, on the regulation front. Let's talk about the law and regulation and perhaps the core sort of diving into specific areas of law and they affect DeFi projects. Perhaps if I could put to you this question of how does, and why does, DeFi pose a bit more of a unique challenge for regulators in the application of laws? Why are we seeing regulators oftentimes speak about how there's uncertainty or some challenges in terms of how our existing regulatory frameworks may apply to DeFi projects? I don't know, Lee, if you wanted to start that off.

Lee: Sure. I think legal and regulatory issues, in particular the concerns of regulators around DeFi, are similar to those that they have with Blockchain more generally, which is regulators, particularly in financial services, are most often focused on what intermediaries are doing and what duties and obligations that an intermediary should have. As Marc pointed out no more intermediaries here. The only intermediary is computer code and when that's the case it presents some really interesting and new ways for regulators to think about what's happening. Right now in the US, and, Usman, let me know or, Michael, let me know if this is the same in Canada, if I have 100 shares of Apple stock and I find Marc, Marc wants to buy them from me for $10,000.00 and I'm willing to sell it for that price, he and I can engage in a private transaction with no intermediaries. There is very little in the way of regulation around that transaction although the anti-fraud provisions of the Federal Securities Laws still apply. So if I defraud Marc, or he defrauds me, we would have a claim against each other. But because there's no intermediary, I am not functioning as an intermediary, I'm doing it on my behalf, there's no registration obligations and there's no sort of world of regulation that comes with being an intermediary. That's very much what DeFi is reproducing on decentralized Blockchains. So looking to try to find an intermediary can be difficult when, as I said earlier, Lee Schneider creates a pair on Uniswap and just sort of plays around to see what happens with it. So I think that's the main source of thinking around regulation and whatnot. There's sort of a sense, I think, among regulators that somebody's got to be responsible for this stuff. It's not 100%25 clear to me that needs to be the case and we'll just take a short detour here. I think these issues, by the way, are not just issues with respect to Blockchains and DeFi but these are going to be issues with respect to machine learning and artificial intelligence. Because effectively we're going to be seeing the same thing happening there. People are programming ML and AI and then ML or AI is going off and doing stuff and making decisions that even the programmers can't quite figure out why it made the decision that it made. Figuring out who should be liable under those circumstances is presenting some really interesting philosophical questions for lawyers and regulators and policy makers.

Usman: Marc, what about you? Why is this area, in your view, somewhat challenging for regulators and the application of laws?

Marc: I think Lee touched on a lot of it. Especially from a policy perspective. I think if you actually just dig into the statutes. With US lawyers, I'll talk about it from that perspective, and you look at the '34 Act, the Exchange Act. What is that regulation concerned with? It's concerned with the action of this centralized exchange and what it may or may not do. Whether it is reordering order books or it's employees stealing funds that are on the exchange. Similar issues with the kind of broker dealers and needing to oversee employees. So it's very much focused on centralized intermediaries. If you look at the Commodities Act, the CFTC, and we saw this with Berkovitz's comments. It's very focused on kind of having centralized trading facilities there to be able to have certain rules and protections and obligations in place. That's just how the laws currently are written virtually across the board. Really the exceptions are probably I think anti-money laundering and ... sanctions that are a little less focused on intermediaries, although I think they're still very relevant for anti-money laundering where a lot of the statutes focus on intermediaries, but not only intermediaries. So I think that gives regulators a lot of difficulty when they look at it, and they look at the laws, and they say, "Okay. So who's the intermediary here?" and the answer is there is none. So what does that cause regulators to do? The initial inclination is who created this? So we want to look at who created that. If you look at the statutes there are certain things you could try to pull from. Secondary liability concepts. Things like that that regulators could try and hang their hat on. But definitely nothing firm. That gives pause to regulators as to like how should we handle this from a both strategic perspective but also from a policy perspective. I think that one of things beyond intermediaries, that I'd say that laws focus on, is you've got centralized actors but when it is that centralized is no longer centralized and we can no longer attribute the actions of people to like one person. The easy example of this is if you've got one person taking an action it's pretty easy to know who it is. If it's 30, probably pretty easy. If it's 100,000, all coordinating over the internet, even if you're not talking about like an intermediary concept, like who do you hold liable in that concept? In the US we might look at concepts like general partnership. But are you really going to find a general partnership exists among 100,000 people who are coordinating, some more passively than others? Very hard to decide so I think all those things are kind of difficult for regulators and even private litigants to try to figure out.

Usman: Yeah, I mean that's certainly what we've been seeing in Canada as well. This area is very difficult because our laws have presumed that there's intermediaries and so it's difficult for these projects and the DeFi projects, the claims that one may have, because the legislation in effect is not, rightfully or wrongfully, technologically agnostic or neutral. It presupposes that there's an exchange. It presupposes that there's a clearing agency. It presupposes that there's a bank. So a lot of these projects come with the intent of disintermediating and so statutorily you're already in a problem. Then as we've seen many regulators talk about is that often regulation is affected through intermediaries. We apply regulation to the intermediaries to be able to put protective efforts here, to protect investors or consumers or what have you, so what happens then if you no longer have those intermediaries as part of the system? Then when you're dealing with the decentralized projects, another issue that we've seen come up time and time again, is that it's really the point that you were raising, Marc, which is who do you then regulate in a decentralized function or a project? Is it the code or whoever drafted the code? Is it the Blockchain itself? Is it the users? So that is another really critical question that we've seen time and time again. I don't know, Michael, if you had any more thoughts on that before we dive into some of the more specific areas of law.

Michael: Yeah, I mean it is interesting and, Marc, you mentioned a point that we've seen comments made, can regulators just say DeFi decentralized protocol, it's subject to regulation just because it is and then rely on users to then put pressure on the different projects, on the different DeFi protocols, to subject themselves to regulation and sort of hope the market moves in that way. I think Usman will probably agree the problem there is that when it then comes time to enforcing, whether it's securities laws or AML laws, things that have not been thought through properly about how the existing framework apply to these projects or protocols, then you run into an enforcement problem later on down the road. So that's really interesting and the question, I guess from a regulatory perspective, do you try to force the current frameworks in place, maybe adjust them slightly, but impose them on the different projects or founders of these protocols or do you try to build from the ground up? I think, at least AML maybe has approached this in an interesting way because they've created essentially a new category of providers. A new category of financial assets subject to regulations. So they've created this virtual asset service providers and seem to be consistent in the way they're approaching it from country to country, thanks to organizations like ...

Usman: So maybe if I can continue to pick on you, Michael, what are some of the key legal issues that we see coming up with these DeFi projects? Maybe I can hand it over to you on that point.

Michael: I think it's really the similar types of legal issues that we tend to see for any type of FinTech project or Blockchain type project. I don't think there's anything unique just because it's DeFi. So you have certainly anti-money laundering concerns, sanctions when dealing with transfers of funds and, in this case virtual assets, securities laws and banking. I think those are the main areas that regulators will be focusing on and have focused on. I think the issue with DeFi, and I think you mentioned this, Usman, it's who do you apply these regulations to? Whereas AML regulators seem to have approached it in a way that might be innovative. The question is when looking at securities laws how could they apply to the different projects, different protocols? The main test that we look at when advising clients and even when working and meeting with regulators, it's the Investment Contract Test. So in the US it's how we test and in Canada we call it the pacific coin test and the question of whether the conditions or components of that test apply in a DeFi space where in the development of a project, or participating in a protocol, entitles the user to, I think what they refer to, as governance tokens. Well, are those governance tokens securities? I think Lee had, when we were talking about this earlier, you had an interesting point. Is that really an investment scheme? These tokens are not being issued to raise funds in order to put these projects together. These tokens are issued to participate in decision making of the protocol. Are the conditions of how we test met? Lee, you had something interesting that you were mentioning before on that front and questioning whether it really did apply.

Lee: As people who know me have heard me go off on this topic too often, Marc and Usman each have had the displeasure of listening to me rant on this quite frequently. I do think that the result of a lot of confusion about the way Howey is written. I don't know if that's intentional or not but it sort of creates this idea that anything you will get can be a security. That is so evidently not the intent of the Supreme Court and Howey. What you should be looking at to determine whether or not it's a security is the contract transaction or scheme and that's the direct quote from the Howey test. So you're not looking at the object of the contract transaction or scheme. You are looking at the contract transaction or scheme itself. That kind of presents some difficulties if you determine that a contract transaction or scheme is a security. So it's much easier to say the object of the contract is a security rather than the contract itself, for example, being a security. But that is diametrically opposed to what the Supreme Court said. Supreme Court did not say that oranges were securities in the Howey case. They did not say that orange groves were securities in the Howey case. They said that there was a contract transaction or scheme involving oranges and orange groves that was a security. Thinking about all of the different things that are happening in the Blockchain space, and in particular thinking about Blockchain tokens, from that perspective had lead me to believe that Blockchain tokens, overwhelmingly, are oranges and not securities. But I do want to follow up on one other point that we've sort of been talking about which is this point about intermediaries. This point about code. This point about the technology. It raises, I think, very interesting questions about liability and responsibility. But one of those interesting questions to my mind is often regulations are designed to protect people from certain outcomes. But at least in my experience over the last 57 years plus, is there's oftentimes people don't want to be protected from stuff, or at least they start out not wanting to be protected from stuff. So it raises this sort of interesting question of should there be zones or situations or areas in which people can opt out of the protections that the law or regulation would afford them. That's a challenging question. It's one that I don't have a firm answer to in my own mind, but I think it's a question that is in a lot of ways being raised by what's happening in the DeFi space because, man, if I had messed up when I created that trading pair on Uniswap it would have been all my own fault and there was nobody that I could go to to say, "Whoops. I messed up. Fix it for me." I knew that going in and I acted accordingly with the amount, so it's tokens that I put into my trading pair, the amounts that I was comfortable losing. But at some point do we say, "You know what? The same way we've let people gamble. Maybe it's okay to let people engage in this kind of activity outside the protections of what the law affords. As long as they've opted out of those protections."

Usman: So I've just two follow ups to your point, Lee. The first is to note that there was a settlement yesterday involving coin schedule and two Commissioners, Commissioner Hester Peirce and Commissioner Roisman, issued a public statement, not dissenting from the settlement but noting, and that was a case in which Coinschedule had publicized quite a number of tokens, over 2,500 is my understanding, and they said, to your point about the lack of clarity surrounding the nature of digital assets, they said, "We nevertheless are disappointed that the Commission settlement with Coinschedule did not explain which digital assets touted by Coinschedule were securities. An omission which is symptomatic of our reluctance to provide additional guidance about how to determine whether a token is being sold as part of a securities offering and which tokens are securities." Then they go onto note that in this void litigated and settled Commission enforcement actions have become the go to source of guidance. I think that that's what we're seeing. Some regulatory pronouncements saying this token is in. That token is out. Without necessarily a clear framework. I do take Commissioner Hester Peirce and Commissioner Roisman's comments with weight because we see that issue coming up time and time again. The second point is that I'd be curious to hear your views on actually the Safe Harbour proposal 2.0 that Commissioner Hester Peirce had advocated for which was almost like a safe harbour, this exception if you will to allow token projects, including presumably DeFi ones, to get to a certain stage. I don't know what your thoughts are on that. So long as they're moving towards decentralization. I don't know if you want to just maybe explain it very briefly, that proposal, and your thoughts on it.

Lee: Sure. I'm a big fan of that proposal. Not because I think it's perfect. Not because I necessarily think that it accurately follows Howey, and the interpretation of Howey, which I believe to be correct but I articulated that a little while ago. I'm a big proponent of it because I think it does a pretty darn good job of solving a lot of the issues that we see out there in a way that should be embraced by all sides in the debate. I think it cuts line to my mind in a really good way. The basic proposal is that a token sale would not be considered to be a security when it's made and therefore not subject to the registration provisions. The tokens also would not be considered securities such that crypto assets exchanges could trade them without having to register as broker dealers or National Securities Exchanges and a few other similar roles like that. All would be sort of obviated for a period of 3 years and at the end of that 3 year period the project would have to submit a report to the SCC explaining why the project is sufficiently decentralized such that the token should continue to not be treated as a security. There's a little bit more detail to it. It's not just sufficiently decentralized. There's other ways to measure it as well but that's sort of the general concept there. I think it's a good proposal because, as I said, there's a lot in there for all parties to embrace. The anti-fraud provisions of the US securities laws would still apply. The nice thing is that the Safe Harbour would not take a position on whether or not the particular token is a security but rather would sort of say, "Look, we don't have to solve that problem right now. We can allow the project to focus on innovation. We can allow the project to focus on trying to change the world." or whatever it is that it's trying to do, rather than have to sit and sort of worry about whether the SCC is going to, in a post hoc way, determine that the token is a security. From that perspective, and I wrote an article when Commissioner Peirce came out with the first draft of her proposed Safe Harbour in February of 2020, saying how much I liked it for these very pragmatic reasons.

Usman: Marc, what about yourself? What are some key legal issues that you see coming up with DeFi projects? And if I don't mind asking you another question which is, what other challenges do DeFi projects have beyond the law that you see coming up, time and time again?

Marc: Happy to cover both of those. I like going through that first question because it gives people a sense of the breadth of the issues and sometimes these all come together simultaneously. Oftentimes it's the frustration of having to do the analysis because if one doesn't apply securities laws and so from that perspective you look at the Securities Act. You also need to look at the Exchange Act. You also need to look at the Advisors Act. You also need to look at the Investment Company Act. All under securities laws and, frankly, these DeFi protocols are so complex that there's a likelihood that it triggers one or more of those. It might not trigger any but you pretty much can't ignore those analysis because some of them could. Then I think once you get past that you look at the commodities laws. The commodities laws are pretty much going to always apply. Now, the breadth of their application is the question. It depends on whether you're dealing with derivatives or really spot transactions and commodities but, regardless, commodities laws apply. Then you need to go look at the anti-money laundering laws and say what are our obligations there, if any? Then you need to go past that and you need to look at sanctions and say, what your obligations with respect to the sanctions regime. Then you need to go beyond that and you need to say, what about consumer protection? Because arguably where all this should end up is in a consumer protection world. Securities laws shouldn't apply because you're solving various policy considerations that are problematic otherwise. What is going to exist is that you're providing a user interface that could very well not being displaying proper interest rates, or whatever it might be, and that consumers should have proper information about what they're dealing with. If you are going to offer a user interface rather than user's directly accessing a protocol. So you've got that. Then you start gathering protocol specific issues. Are there lending laws issues. Are there insurance issues? What that paints a picture of is that every project needs to go through this massive analysis of what applies. They all change in various ways and there's no perfect way to analyze them all at once in some perfect way where we could write one thing and say this applies to all. So I'd say that's the hard part and that's, frankly, one of the key challenges facing DeFi projects, honesty, is that mishmash of regulatory regimes. Once you get past that I think there's a bunch of them and I think some have more importance than others. I think when you see the traction that DeFi protocols have had, one issue is scalability. Inherently Blockchains are slow and with time, and with more use, they become expensive as well. Some protocols are making trade-offs where they might actually be faster. There is almost always inherently a trade-off when you do that. Sometimes centered around fewer nodes in a network. Various trade-offs. So that's something that should be considered. The other thing that we're seeing is layer 2 solutions that exist. That effectively means, one example would be take group transactions together and then batch them onto the initial Blockchain all at once so that you're not sending thousands of transactions, you're sending one transaction at a time, making it cheaper and clogging that network less. Scalability is definitely, I think, a big issue. I think I touched on this earlier, I think the ability to coordinate properly is a difficult task. Some DeFi protocols are very simple. If you look at Uniswap it's like X x Y = K, is like the formula that drives the pools under the Uniswap. That's pretty much how it works. There's different versions of Uniswap when talking about merging 1 and 2, let's not get into version 3, it's a little more complex. There's really nothing that needs to be changed. It exists and nothing needs to be done. But then when you start going to the protocols like ... Compound, you start needing to actively add assets. You start needing to actively set interest rate floors and ceilings. You start needing to set collateralization ratios. So somebody needs to do something about and so coordinating over that is very difficult. Similarly when you're doing it online, the technical level, I think the difficulty is less. When you start doing it in a real world example where you suddenly need to coordinate, as I was saying earlier like deploying capital, and how you actually continue to have these projects evolve. There's a reason we have corporations and why they've existed and why it's been like a good vehicle of growth, historically, is because centralized decision making is very efficient. So when you're talking about decentralized protocols, that still need to be managed and want to grow in one way or another, how do you do that in a decentralized way that continues to move it forward rather than reaching a point where it's stale and not growing anymore? So those are some of the difficulties. Frankly, there's so many little ones around the edges that teams deal with all the time. But I think scalability and offchain coordination are probably some of the biggest.

Usman: Right. So, I do see that we're at the hour. My little tickler thing, the little bell that we were talking about before hand, Marc, and that we don't like hearing about the next meeting or the next session or what have you, has gone off. But maybe, Lee, if I can give you one last word, if you don't mind, on just any challenges or any other thoughts before we wrap up.

Lee: Look, I'll go back to a point I made at the beginning which is this is all about the code and so if you trust the code then, by all means, this is a great thing. If you are adept enough with code that you could do a code review yourself, then make sure that the code functions correctly or at least the way you expect it to, then more power to you. That is definitely not me. But this importance of code is hugely significant in many, many ways to DeFi and so I think that's really where the ballgame is going to playout for a while now. How good is code? Is the code flexible? Does it allow you to do the things that you want to do? How are people going to review that code to make sure that it works properly? I'm looking to see what kind of developments are going to happen in that area, most particularly, because that's going to potentially solve some of the problems that we have been talking about, particularly for the regulators.

Usman: Right. Well, thank you to all of you. The time really flew by. I ended up learning a lot from this session as well so thanks for that insight, not only from you Marc and Lee, but also from Michael as well. I wanted to remind everyone that our next session, we're going to take a month off, we've been hosting one of these webinars one very month, but we're not going to have anything in August. We'll resume again in September and that session is on 'Intellectual Property and Open Source'. To be followed again, the following month, with a webinar on 'Blockchain litigation'. Again, Lee, Marc, Michael thank you so much for joining and thank you everyone in the audience for joining as well. Have a great day.