When token sales and ICOs took off in 2017, most projects chose to push ahead despite large regulatory risks. One of the few that went the other direction and put compliance first was CoinList. The platform made its debut by running the massive Filecoin token sales in which $205m was raised from accredited investors. CoinList also played a major role in popularizing the SAFT and creating tools to efficiently and legally raise in the US.
We were joined by CoinList President and Co-founder Andy Bromberg to discuss the history of CoinList, token sales, securities regulation and the potential of security tokens.
Topics we discussed in this episode
- How Andy became interested in Bitcoin and co-founded the Stanford Bitcoin Club
- The Filecoin token sale and CoinList’s genesis story
- CoinList’s due diligence for listing projects
- Why they created a whitelabel token sale offering
- The regulatory framework under which CoinList token sales take place
- The logic behind the SAFT (Simple Agreement for Future Tokens)
- How a token could transition from security to non-security
- The recent SEC crackdown on projects that did ICOs
- CoinList’s stance on security tokens
- Microsoft Azure: Deploy enterprise-ready consortium blockchain networks that scale in just a few clicks. More at aka.ms/epicenter.
Brian Fabian Crain: Hello and welcome to Epicenter. My name is Brian Fabian Crain.
Friederike Ernst: My name is Friederike Ernst.
Brian: We’re gonna go to our conversation with Andy Bromberg in a minute. He’s the co-founder of CoinList which has done a massive amount of token sales in the forefront of regulated token projects in the US.
Friederike: He will talk about the ICOs that they facilitated and what they’ve done for them as well the regulatory environment and how it’s changed with the recent SEC crack down on several ICO project. We’ll also talk about where he sees tokens and token regulation go in the future.
Brian: But before we get to this conversation, we do have a small announcement to make, or big announcement. Well a small announcement. Meher had his first child just about a month ago. He’s taking some time off from hosting podcasts. He’s focusing fully on the baby, family, as well as Chorus One. He’s gonna be back a few months from now hosting episodes. But if you miss him, that’s why. Yeah. Congratulations to Meher. With that, let’s go to our conversation with Andy. We’re here today with Andy Bromberg. Andy is the cofounder and president of CoinList. Of course many people will have heard of CoinList. CoinList is a token platform, or token sale platform in US that took a very kind of approach focus on compliance. They were behind the massive token sales including the Filecoin one. They’ve been very much on the forefront of figuring out, okay, what does it mean to do a compliant token sale in the American framework? Yeah, thanks so much for joining us today, Andy.
Andy Bromberg: Thanks for having me.
Brian: I guess to start off, I saw that you were, you went to Stanford as an undergrad, and then you started the Bitcoin Club there. How did you originally become interested in crypto?
Andy: Yes, it’s an interesting story. I was at Stanford studying math and computer science and took this class. I talked to my professor named Balaji Srinivasan. It’s a name some people might recognize. He’s now the CTO of Coinbase, and was the CEO of Earn.com, and before that a partner at Andreessen Horowitz. But before that, he was teaching at Stanford. He taught this amazing class called start up engineering. A bunch of us took it. It’s hackathons, he built really cool things. Then after the class, a small group of us kept spending time together including Balaji because we were just really interested in some of the topics that we’re talking about. He ended up saying to us, Bitcoin is going to be important. You guys should be paying attention. You should buy one. Sadly, not enough, but you should buy one. We should get involved. That group of people spending time together after that class ended up becoming the Stanford Bitcoin Group. There were seven of us. Students that started in Balaji and Vijay Pande who was another professor and another partner of Andreessen Horowitz. We spend a bunch of time over the next couple of years doing research. Bitcoin was really, is around the same time Epicenter started. Really, around the time it was only Bitcoin. People weren’t talking about blockchain technology or tokens or anything like that. We spent a bunch of time doing research on Bitcoin, its applications, building cool little toys, doing some evangelism, running around, pitching people on the importance of crypto. It was a really fun experience back in 2012, 2013, 2014.
Friederike: Then you went on to found CoinList with Graham Jenkin, right?
Andy: Yes. There’s five of us founders at CoinList. The story with CoinList getting started is that Protocol Labs who built Filecoin wanted to run the Filecoin token sale. They knew it was going to be big and important and a kind of milestone for the space. They started putting together this place to sell their token. In the process they realized they needed some help on the compliance front. They brought in an AngelList, prominent, private fundraising platform here in the US, and brought an AngelList, and they worked together to do the Filecoin token sale. Midway through that process, they stepped back and said, wow, this is really hard. It’s costing us a lot of money to develop the product, do it legal. In every single token, he’s going to need to do this exact same thing. This should probably be a new independent company. CoinList ended up spinning out of AngelList as an independent company last year, a little over a year ago to do exactly that, to be a platform for the best digital asset companies to manage their token sales. The kind of five founders of CoinList, myself and then four folds, Graham, Paul, Brian and Josh from AngelList came over and got this thing started.
Brian: You mentioned you became interested in Bitcoin very early on and had this involvement with the Bitcoin club. But then CoinList was pretty recent, you decided at the time you didn’t want to go fully into crypto space.
Andy: Yeah, that’s right.
Brian: What was the reason for that?
Andy: No, it’s a good question. I left school in 2014 and started a company totally unrelated to crypto called Sidewire in the media space, political media space. I maintained my obsession with crypto throughout that time. But the reason I didn’t go into crypto full time because was that I felt like it was a coin flip at that point, it’s 2014. I felt like it was a coin flip, whether or not there was going to be one cryptocurrency, crypto asset, cybercoin, whatever you want to call it. Whether there was going to be only one. Bitcoin is going to be it. Or if they’re willing to be a ton of tokens, coins, digital assets. At that point, I just couldn’t tell. I was 50/50. I was looking at it and saying, startups are already hard enough. They have a massive failure rate. I don’t want to add an additional 50% nutrition rate onto that. Because anything I could think of doing, relied on one of those two outcomes. Relied on one of those two thesis being true. I just felt like I couldn’t tell. I didn’t want to add a 50% failure rate onto what is already a very hard thing to do. I said, you know I’m gonna come back to the space when I feel like that question has been answered. I now feel like that question has been answered. There’s going to be more than one cryptocurrency out there. Obviously CoinList is predicated on that assumption. That’s what kind of pulled me to come back into the space and work on it full time, now that I feel like that decision has been made.
Friederike: You are the CEO until earlier this year. Then stopped down and became the president. What’s the story behind that?
Andy: Yeah, it’s a great story. An interesting thing about crypto that differentiates it from a lot of other industries is that because it’s so early, you guys know this well, it’s global, and the value of being out there publicly is really high. There’s just a lot of uncertainty, there’s a lot of confusion out there. Having a message that’s out there is way more important than in most startups where you should go in and just focus on kind of building a compelling initial product in shipping that. It’s important that we spend time out in the world and evangelizing where the space is going. Earlier this year, I was spending all my time doing that. I was working on sales, working with issues, trying to guide people in the right direction. I was travelling, I was doing all of this. It was such an early company, ten or fifteen people at that point, that I just wasn’t spending the time I needed to be spending back home at the company. We said, myself and the board, we said, we should really bring someone in to run this company so I can do what I do best, which is getting out there and interfacing with all these external parties that are critical into the crypto ecosystem. We found the perfect person. Paul Davison, now the CEO of CoinList came over. He was running a big chunk of product to Pinterest. He had sold his last company to Pinterest. He worked at Google, on Metaweb, done a whole bunch of amazing things and was just the perfect person to come in and really lead CoinList, the company, which freed me up to go and focus on all the external face and things that I think are really important in this industry.
Brian: Among these external things, what are the ones that you spent most time focusing on?
Andy: Yeah, it’s pretty wide variety. But I think the highest leverage piece is sitting down with really high quality token issuers that maybe don’t have it all figured out. It’s interesting when you start a startup, there are now years, decades of kind of case studies built up on how to start a startup, what you should be doing, what the best practices are, how you should structure things, what is the seed fundraising like? What does a series A fundraise look like. In the crypto space, we’re so early, especially within tokens in particular, we’re so early that there’s just not a lot of data points. These amazing teams are coming in and saying, well we know how to do our thing, which is building this product, building this platform, supporting this token network. But we don’t really know how to structure our sale. We don’t know how to market. We don’t know how to build a community. We don’t know how to do all this extra pieces. It’s something that we’re in a unique position. We’ve seen now, thousands of these token sales, and can figure out how to help them. I think the highest leveraging I do is sitting down with high quality teams. This isn’t something that we charge for. It’s not a service of ours. But if we think it’s a really high potential project and we might want to work with him in the future, I’ll spend hours sitting down with them, going through, how should you structure your sale? How should you think about strategy going forward? How should you think about the different dynamics of this network build in a community, and helping them make sure that they have the best chance of being successful? That then is what leads to really successful token sales, really successful Airdrops, really successful community building efforts. That time that we spend with those issuers, trying to get them on the right path I think is probably the most valuable thing that we do.
Friederike: Once you’ve onboarded these projects, what kind of services do you offer to them?
Andy: Yeah, so CoinList today four services and I’ll sprint through them. The first is the service that we’re kind of most known for, which is the full sale product. This is what we did for Filecoin blocks add, crops, or gin trust token, but only those five. I say that just to note that it’s a really high barn. We’ve worked at five in the last year or so. Out of about 2500 that have approached us, and that’s super selective on that. When we do that, we post the sale on our platform. We handle the compliance of KYC, AML accreditation if that’s relevant. The transaction process, the document signing, the token distribution, really the whole nine yards of logistically running the sale. Then we market the sale to our community of investors. We’ve got many, many accredited investors in the platform ranging from your average accredited investor all the way up to institutions, funds, endowments, family offices. We work on both logistics of the sale, and also potentially helping to bring capital in. That’s one service. The second one is CoinList’s token sale manager, which is effectively the same, but just without the marketing and endorsement. It’s just the infrastructure to run the token sale. Again, compliance, transaction, processing documents, token distribution. But without us kind of endorsing the project, or pushing it to our investor base. That’s the CoinList token sale manager product. Our third product is the CoinList Airdrops product, where we help issuers give away token. We built a structure that’s compliant in the US and internationally to give away tokens even if there might securities. We have a big community to send those to the, the first one we ran was the Dfinity Airdrop which is a really exciting to give away $35 million dollars’ worth of tokens to tens of thousands of users. We have some more exciting ones coming up. But soon on that. That Airdrop product will also include things like developer bounties, and kind of proof of care systems. We can talk more about the future of that. But we’re really focused on effective targeting there. The last product, we’ve actually just announced yesterday, is CoinList Build, which is our product to help token networks host online hackathons to build their developer communities. Online hackathons are an amazing concept, it really fit in with the crypto ethos of being global and distribute and open democratic, where people can go and build on top of these platforms. Our first hackathons we’re hosting for Zero-X. It’s really exciting, awesome team. That will happen in January. Every participant that submits a projects gets a hundred dollars Zero-X tokens. There are awesome grand prizes that Zero-X has donated $10,000 in Zero-X tokens for the winner. It’s focused around bringing decentralized markets to the masses. How can you build compliance on these decentralized markets? How can you do interesting things with NFTs and gaming on these decentralized markets? How can you build an ecosystem of decentralized finance? We’re really excited about that hackathon. We have a bunch of other ones in the pipeline to keep the support going, and keep building these developer communities. Those are the kind of four CoinList products. Full sale, token sale manager, Airdrops and CionList Build, and of course more on the pipeline as well.
Brian: I’m curious regarding the full sale versus the token sale manager. Why didn’t you guys just choose to have an open platform where you have like a wide variety of projects that can do token sales through that?
Andy: Yeah. I think a big piece of it for us is that the space is so filled with noise. It’s really hard to separate the signal from the noise. Because it’s so young, most investors don’t have an ability to really effectively do due diligence on these projects. It’s getting better every day. But especially if you look last year, investors just didn’t know how to determine if a project is good or not. We said, well we think we have that competency in house. Let’s make this a little bit easier for them. We’re not gonna say that every one of our CoinList fall sales is going to be massively successful. But we’ve at least done our diligence. I’m comfortable with the idea of the token value in the long term, of being useful. The team being good, the product being good, the market being big. I just think that’s a really useful service in this space. We of course want anyone to be able to run token sale. That’s what our token sale manager product is for. But being able to separate out the single from the noise a little bit, so the investors can come and say, okay, I have confidence that at least a minimum bar of diligence has been done here. Now I can do my own diligence, make my own decisions. But I can feel comfortable with the projects listed on this platform. I think it’s a really valuable service to be providing to the space. Just having that aura of high quality projects, especially in a time when there are so many low quality ones, I think is really important for us in building the company of the future.
Friederike: Interesting, so when you say, you do due diligence on these projects, do you mean in a legal sense? In the sense that you determine that they are not scam, and they’re not a security and so on, or do you mean that you also look at that token model and see whether you think that’s going to work in the future, and whether it makes sense from a crypto economic point of view.
Andy: Yeah, all of the above. There’s generally kind of six things that we look at when we dig into one of these projects. The first four are things that I would say you should do for any startup you’re investing, whether it’s a token, or not. Look at the team, the product, the market, and the deal terms. Is it a strong team, do they have a compelling product, is it a big market they’re going after, and do the deal terms make sense? Are the terms, terms that you should think about investing at? We do that. Then once we get past that there’s two things that are kind of unique to token diligence instead of startup diligence. One is what you were saying, the legal diligence. If you’re investing in a normal startup, no one’s really innovating on the legal structure there. The financing of the company. You don’t really need to do that much legal diligence. But in the token world, obviously we’re innovating left and right on legal structures. We have to get comfortable with how they’re operating from a legal perspective. The last piece is the token economic piece. That means, us getting confident that the token needs to exist, that the token will accrue value in the long term, that all the parties in the network are properly incentivized, or dis incentivized to behave in a way that’s desired by the network, and really knowing about token economic model, I think it’s a place where a lot of teams we talk to fall short. There’s obviously a massive class of scammy, low quality projects that we see. We can throw away out of hand. But the hardest conversations are ones where we sit out across from a really good team, with compelling products and the big market they’re going after. We look at them and say, listen, we just, we don’t think, and we could be wrong, but we don’t think your token needs to exist. We don’t think it’s going to accrue value in the long run. Or we think that there’s some flaw in the token economic model that will cost an incentive for the network to be attacked a dis incentive for a key party to act in the right way. A lot of projects use this kind of field of token economics is so new, don’t really have the ability to put that together, and that’s where they fall short.
Brian: You mentioned the five token sales that you sell which tended to be in a large and well known projects. But I think this were all last year. Have you guys done token sales this year?
Andy: Yeah, origin in trust token were this year, but they are few and far between. One thing that our token sale manager product is used for the white label one is private sales. Some of those are really high quality projects that would absolutely pass our diligence for the first category. But they don’t need the marketing because they’re choosing to run a private sale, and they just want the infrastructure. What we saw was a lot of the high quality projects in 2018. Decided to run private sales instead of public sales. We still help them, of course, but just not in that public manner, because that wasn’t the service that they were looking for.
Friederike: There was a recent post announcing that CoinList is now a hundred percent free for investors. All the money raised goes to the project itself. How does CoinList make money?
Andy: Yeah, so we moved pretty simply from charging investors to charging projects. I think what we’re seeing was that investors don’t want to pay. They’re already paying for their investment. Projects don’t really want their investors to pay. They’d much rather pay themselves out of their own kind of treasury management and financial budgeting, than making their investors pay. We just change, flip our model around and we think it’s gonna result in dramatically happier investors, and issuers. Pretty simple change to be totally honest. But I think the optics of that matter a lot to investors. I want to make sure we’re serving everyone in the best way possible.
Brian: Can you speak about, what are the fees that you charge both through the token sale platform and the manager?
Andy: Yeah. It really varies depending on the deal. I think for the full sale product, it tends to be a percentage of the funds raised because we’re actively participating in kind of pushing the deal out there, and getting capital into the deal. We take some percentage of the funds raised. On the token sale manager product, that price was kind of a flat fee, very low, tens of thousands of dollars, above a certain number of investors, per investor fee of processing costs. Again it varies on the exact details of the sale. But that one’s more of kind of like a sass model. While the full sale business has a percentage based model.
Friederike: You can’t really talk about token sales without talking about regulation. What’s the regulatory framework which CoinList has used so far?
Andy: Yeah, so our view is that, we’re generally focused on people that touch the US in some way. Whether it’s a US issue or it’s an international issue hitting you as investors, that’s the place where it makes kind of the most sense to start when you talk about international pieces as well. But from the US perspective, SEC Chairman Jay Clayton has said a number of times, he hasn’t yet seen an ICO that wasn’t offering securities. We take that same stance. We think it’s possible, and there’s actually some coming up next year that we’re excited about potentially being non-secure of these offerings. But thus far we think that functionally every ICO has been, or token offering has been offering securities. Now, very important there is that, that does not imply that the tokens will always be securities. It just means that at the time of the initial offering, when the issuer is selling them to our first set of investors, the SEC thinks that those have been securities. Most often, projects that work with CoinList use something like the SAFT framework. Now there’s a bunch of different names for different documents. But they all are, get up to the same core idea which is, we’re going to sell you a piece of paper. It’s called the SAFT, Simple Agreement Future Tokens. This piece of paper is a security. You’re participating in a regulated security offering and has to be registered or exempted appropriately. We can talk about the different option there. At some point, we think that the underlying token will no longer be a security. At that point, this piece of paper will turn into, our output those non security tokens, and then you’ll have this wonderful non security token in your hands as a result. That is the overall framework that most issuances that have worked at CoinList have used. It’s something we still believe in at a high level that that concept of, we’re gonna sell you a piece of paper, a security, and eventually it’s going to turn into something else. I think the big, open question is, where’s that line? How do you draw that line? How do you decide when something is no longer a security? We have lots of thoughts on that. But that’s kind of the big, outstanding question, I think, people have for the SEC. It’s become clear that it is possible to have that line. Now it’s just a matter of drawing where exactly it falls. One note on that, I think the clearest encapsulation of why that transition is possible comes when you put two senior SEC official statements together. SEC chairman Jay Clayton saying, I haven’t yet seen an ICO that there was offer of securities. Then, SEC Director of corporation finance Bill Hinman saying, he doesn’t think Ethereum is a security. You put those two together, Jay Clayton has almost certainly the Ethereum ICO. It would be kind of absurd for him to have missed that one. If those two officials’ statements represent the final position of the SEC, which of course is in question, but we think is likely that you hear effectively the Ethereum ICO isn’t offering securities. Then you hear Ethereum is not a security. That means that that line is possible to cross at some point, and it’s just a matter of when and how. Those are questions that we are actively trying to get good answers to.
Brian: Where do you fall so far? What do you think are, I guess, on the one hand, likely stance that you’ll see this take on this question? What do you think would be a good way to actually answer that?
Andy: Yeah. The two clearest paths I have seen so far for a criteria that would mean something is not a security. One is a pretty simple one, which is that you hear a lot about the Howie test, which is this test of whether or not something in the US an investment contract, which would mean it’s a security. It satisfies these four prongs of the Howie test, so that there’s an investment of capital, and a common enterprise, made by efforts of others, and with an expectation of profits. That last prong is an interesting one because we have this wave of stable coins. I feel like the last six months have been the half year of stable coins. Everyone’s talking about them. But an interesting kind of foot in the door strategy here is that stable coins, by definition, if you sell the stable coin itself, not some associated token that changes in value based on the success. The stable coin itself, by definition, doesn’t have an expectation of profits. If we have a stable coin that tracks the US dollar, and someone invest with US dollars, I can pretty definitionally say that they are not expecting profits from buying that stable coin. That would be a really interesting thing to go and say, we’re selling the stable coin. We think it is a good one because it fails the Howie test. It’s not an investment contract because there’s no expectation of profits. Then all of a sudden, we would have a token out in the world where it’s not a security. That I think is a really effective food in the door strategy. It doesn’t help most tokens that do kind of, have floating prices and vary. But it would be a way to get a token out there that’s not a security. That’s one. I think the more interesting one and that’s still a little bit up in the air is what Bill Hinman, again, the Director of Corporation Finance who talked about Ethereum not being a security said, which is that it’s sufficiently decentralized. You don’t this hear this phrase tossed around a lot, sufficiently decentralized. What does that mean? Great question. We have no idea. But, that concept is implied, would mean that something is no longer security, because it’s kind of not dependent on the efforts of others. It’s not dependent on the efforts of this issue in party. I think a lot of attention is going to be focused around what does it mean to be sufficiently decentralized? How do you we set some sort of quantitative, or semi quantitative criteria for that, and how can token networks fight to get there. I think that’s the really interesting next frontier in terms of security regulation in the US on these assets.
Friederike: That’s very interesting that you say it can depend on the efforts of others as long as the others are not centralized. I think that’s a super interesting point. People have also been giving out a lot of what’s been called utility tokens, right? That in principle, a design not to be secure keys anyway, but you think they’re being perceived as security. How, what kind of users these utility tokens actually have to have in order to not be a security?
Andy: Yeah. It’s an interesting point. Again, I’m speaking largely from a US perspective here. Obviously laws are different in every country, every state, province, everywhere has a different set of a criteria. I don’t like the terms utility token. The reason I don’t like it is because it carries with this implication that if your token can be used for something, it’s not a security. That is not our belief. There are many securities that can be used for things. Just calling something utility token and saying you can use it, to us, does not mean that the asset is not a security. We don’t like that term. I prefer the kind of convoluted and painful to say, but slightly more clear term, non-security token. You’ve got security tokens and things that are non-securities. It’s a matter of figuring out a way to get them there. I believe in the concept of non-security tokens, utility tokens. It turns out that according to Bill Hinman, Ethereum is one of those. But the question is, how did you get there, and what is that criteria? I don’t think that, I think people have kind of had a reductive approach that said, if you can use it for something it’s fine. I don’t think that it’s true, at least in the US. But I also think more broadly. The utility token, security token or security token, non-security token divide is actually not a terribly helpful divide. Because it’s purely a regulatory classification. It’s a little bit to me like saying, dividing all websites in the world into regulate and non-regulated websites, that’s not a helpful division of websites. You know regulative websites can sell tokens or guns or alcohol, or anything. Those are all wildly different businesses that don’t have a lot in common with each other, other than the fact they happen to be regulated. In the same way, securities tokens can represent a whole bunch of different things and have wildly different characteristics. Not a lot of similarities. Non-security tokens can look totally different from each other, in the same way that Facebook and Google and Amazon are very different businesses. These non-security tokens are going to be very different, too. I think it’s the next conceptual step for the industry. It’s going to be giving more critical thought to what are the actual categories of tokens. In the same we divide websites into social media networks, search engines, and e-commerce sites, and have this kind of taxonomy of types of websites. I think we need that same thing for tokens. I think so far we’ve taken this kind of simplistic approach of saying, utility token, security token. I don’t think that gives us enough detail to really classify these assets.
Brian: I wanted to ask another question on your point regarding tokens being, the thing around being sufficiently decentralized. Let’s say you have something like a maker where it, I think originally it was called shares, right, and in a way, you have this token which is this kind of governance token. You have a revenue from the success of the system. If I’m just going out and I’m buying this token, and in some way, I am doing it probably with the expectation of profit, and probably from the effort of others, yet at some level it’s decentralized. There’s no central foundation necessary, it has a decision making power. Do you think in general this is gonna be an approach that works, and that you have corporation like things. I guess you could even think of Ethereum in some way as, there’s some similarity, or even Bitcoin. You could say, hey, there is this decentralized organization, corporation like thing. But you don’t have the central power. You think like removing the central power is gonna be the key factor?
Andy: Yeah, it’s an interesting question. First of all, I think just to inject the necessary legal issues here, first of all I’m not a lawyer. Second of all, determining whether or not it’s a security is in the US what’s called the facts and circumstances based analysis. Which means that you have to look at the facts and situation of the circumstances under which you’re evaluating it. It’s a really nuance thing. Reasonable people will disagree on whether or not something’s a security over and over. There are not really lots of bright lines about whether or not something fits into that category. It’s tough to say, I do think that going to this sufficiently decentralized point, even just thinking about that phrase colloquially, I think that it implies two things. One, it implies a lack of a central party. It’s something sufficiently decentralized, almost definitely that means there is no central party that can control the system. That part of your question, yes, I think removing the central party is part of the strategy the people will use. But I also think that even beyond that, it implies a certain degree of decentralization. Again, defining that phrase is really hard. I don’t think we have clarity on what that means, yet. But if you remove the central party, but it’s not a duopoly. Let’s imagine a system that’s governed, proof of sake governed and there are two parties that each have 45% of the network, then a variety of people have the remaining 10%. Those two parties are effectively governing, is that sufficiently decentralized? It is kind of decentralized, but there’s no central, single center party. But now all of a sudden there’s two kind of polls in that system. That then becomes a question of again, facts and circumstances, and where you fall on that spectrum. I guess I would say, removing the central party seems necessary, but not sufficient to reach that level of sufficient decentralization. It’s hard for me to imagine a system with a central party that is sufficiently decentralized, but it’s easy for you to imagine a system without a central party that still doesn’t feel like it would be sufficient decentralized. Does that make sense?
Brian: Yeah, absolutely. Of course the tricky thing comes in. A while ago we did this podcast with Angela Walsh. I don’t know if you’re familiar with her. But she’s been writing. I guess she has this like extremist position in some way. She’s been arguing that the responsibility is somewhere, and you should think of eve like Bitcoin core developers as this centralizing element that has this responsibility.
Andy: Again, it’s one of these things where it’s so hard because of the nature of these determinations. There is no objective truth here. Part of what is appealing to me about a Bitcoin-esque system is sure, most people rely on kind of this core developer set. But not necessarily, right? The minors have to adopt these changes. There is a system of checks and balances there. Or it’s not like that code is just pushed out to everyone and they don’t have control over it. That’s like the obvious counterpoint. She said that a million times. You’re well incorporated to her arguments. But my position is, I feel comfortable with that one because it feels kind of sufficiently without a central party that each, they are all checked and balance across the board. There’s not entity that’s driving it forward solo. That I think is kind of the interesting nuance there. But again, facts and circumstances are really hard to come to a hard determination on that.
Friederike: Do you think it makes sense to actually have this provision about the issue of not being a centralized party? Basically, if you turn it around, that basically says, if you’re down, you can’t issue a security, right? Anything that a down issues can be security by definition. Is that correct? Do you think that makes sense?
Andy: No, I think that goes back to the no central party being necessary but not sufficient for a sufficient decentralization. They could issue something that is still a security if it is not sufficiently decentralized. But just a lack of a central party does not imply that it is, does not directly imply that it is not able to issue a security. I think a down is way further along the road to having a non-security token than a central party is that’s issuing a token. But I don’t think it’s definitionally not a security of a down, as you said. In fact, of course, the famous, the Dao opinion, the SEC said the tokens were securities. That’s obviously a factor that we have to consider in that evaluation.
Brian: We mentioned now, tokens being securities, and then also there’s security tokens. Let’s speak a bit about security tokens. First of all, what are security tokens, and what’s interesting about them?
Andy: I think that’s the right question. It goes back to what we’re saying earlier that I think it’s a pretty silly term that people have gotten very attached to. It’s a regulatory classification. There’s a million things that are securities that are totally dissimilar to each other. You never talk about them in the same breath. In the real world, people don’t talk about investing in some sort of a debt security, some municipal debt security and start up equity as the same thing. Those are both securities and totally different. Very few entities would invest in both of those two things. In the same talking about investing and securities tokens feels a little silly because the security tokens can represent a very different thing. Again, important to start to break down what are these assets, and what are the better sub-categories. If you don’t mind, maybe a brief, I wish I had like a diagram here. But a very beginning taxonomy of tokens that I’ve started to use, that I think breaks down a little bit more, tells a little story about the space. I think there will be way more categories on this, but I have a two by two matrix in mind that yields four token categories that are a little bit more defined than security token and utility token. If you think about these to axis, and I’ve been meaning to write this up, maybe this is the impetus I need to go and do that. Where one axis is the intended regulatory status of a token. Which is either security or non-security. That roughly corresponds to utility token and security token. Tokens can fall into one of those two categories. The other axis, you have the source of value for that token. Which is either real world value, or token network value. You put those two axis together, and you get four tokens in those boxes. Security gets its value from real world. Security gets its value from token network. Non-security gets it value from real world. Non-security that gets its value from a token network. Let’s talk about each of those four. I think it tells a story about how the space could develop. We started in the space with non-securities tokens that got their value from the real world. I would call those store value tokens. Bitcoin, which I consider to be a store value token, is valued based on real world inflows and trust in the system. It’s not value based on the level of activity on the Bitcoin network. It’s not value based on any actual thing happening on Bitcoin. It’s valued based on the value that people imbue it with. That’s what this whole space started with, that store value token category. Non-security getting its value from the real world. Where I think we went next, and this is kind of the story of the last couple of years, is still non-security but getting its value from token network activity. That’s what a lot of us call network tokens, or protocol tokens, and Filecoin will be an example of this, when it launches. Where it’s intended to be a non-security. When it’s in its ultimate state. But it gets its value from the work being done on the network. Not from just being a real world store value. That’s kind of the second category that we have gone to, is from still the non-security category, but going up to the token network spreading the value in the real world. I think what’s next is the adjacency to that which is getting its value from a token network, just like those protocol network tokens. But instead being a security. I call these profit tokens. These are tokens that represent some sort of on chain cash flow. I think the most common example that we have seen of this so far is the tokens associated with stable coins. Whether it’s something like trust token, or the kind of recently wound down basis shares token, things like that where the token is intended to be a security. It gets its value from what’s happening on chain. It gets its value from the token network’s activity, and the value being put into those stable coins. That is an interesting transition that I think we’re gonna go to next. When we transition between these categories, it’s not like the old ones die. I think it’s just adding on a new set. We’re gonna go from just having these protocol tokens which are tended to be non-security to having these profit tokens. Where they get their value from a token network, but they’re intended to be securities, they’re intended to be investments. That’s gonna be the next category in my eyes. That will encourage a lot of the infrastructure around security tokens because that is a security token. It is a token that is always intended to be a security. That infrastructure will get built out. Only once that’s been developed will we go to the last category, which is a security token that gets its value from the real world, which is from the asset back token category. That’s when people talk about equity back token, or real estate back tokens. These kind of tokens that have an asset behind them. I don’t think those are going to emerge in force until we’ve had a bunch of infrastructure built in to support the profit token category. That’s kind of a four part taxonomy store value token protocol token, profit token, asset back token. It breaks down a little bit more than the utility token, securities token. Those last two categories are both securities tokens but clearly very different. Trust tokens, tokens, versus a token backed by a building. Really could not look more different. They just happen to share this securities token regulatory classification. I think that there will need to be infrastructure built out to support that. But that’s the sort of thing that I think whether or not that taxonomy is right, we need to start thinking a little bit deeper about what are these actual types of tokens rather than just dividing it as utility token, and security token.
Brian: Let’s say you have one of these profit tokens. Where the token develops its value from some on chain gap, or protocol or something like that. You mentioned base coin and the shares, the basis shares as an example. They now shut down their project because they basically said, okay, this looks like a security, but the whole protocol is not feasible if it is a security. Now let’s say you have these things that are securities, what does that then mean? I mean, does it mean you’ll have to restrict transfer between just like whitelisted addresses that are only accredited investors, what are the implications of that?
Andy: Yeah, I think it really varies based on how they decide to treat it. But securities trade very liquidly in markets all across the world. Equities, obviously the equities markets are massive and liquid. It’s just a matter of figuring out the right structure in the work you have to put in to make it happen. I don’t think that it, I think it makes it harder to have the liquid markets in something that’s non security, but no impossible. I think whether it means people are registering publicly, like effectively having an IPO for a token, or trading among the credit investors, or trading in certain international markets, I think there’s a lot of ways to handle it. But I think at the end of the day, those profit tokens, by definition, and kind of the taxonomy I outlined, are securities and need t be treated as such and traded in a regulatory way.
Friederike: Where does that leave retail investors?
Andy: Yeah, first of all, I think at some point we’ll be in a world where retail investors access those tokens. Retail investors certainly access public equities in every stock market around the world. That’s a natural ending point. A lot of issuers are exploring Reg A Plus in the US, which is the way to sell to an accredited investors. Lots of issuers use Reg CF, Equity crowd funding. I don’t think this means those investors will be left in a lurch. I just think it means there’s a bunch of infrastructure that needs to be built out to support them. Best practices need to be developed. I think that’s all happening.
Brian: You mentioned the extension here. Now what are the different types of exemptions. I guess CoinList so far is mostly used to one where basically if you sell to an accredited investor, you can sell a security, and you’re basically fine. But can you talk about the different types of exemptions?
Andy: Yeah, there’s a lot of them. I’ll run through, I guess, the four that are most commonly used in the US. To sell securities, or to sell tokens. There are more. This is not an exhausted list. But the more that are most commonly used are Reg D, which is what you mentioned, which is involving selling to accredited investors. There’s a couple kind of sub, specific versions of this, 5 or 6 B, 5 or 6 C. But effectively it means you’re selling to accredited investors. You can sell the security under 5 or 6 C. You can also solicit it publicly under 5 or 6 B you can’t. But it means you’re only selling to accredited investors. That’s one. The second one that’s used often is Reg S. Reg S is a way for a US issuer to sell a security to non-US investors. I think there’s a common misconception in the crypto space that Reg S means, don’t worry about securities laws, which is not what it means. What it says is, don’t worry about the US securities laws because you’re not selling to US investors. But do worry about the securities law and the jurisdictions you’re selling, too. If you’re selling to a German investor or a Singaporean investor, or South African investor, follow that country’s security laws. That’s kind of the second exemption that people use. CoinList has built out support for dozens of these countries. Local securities laws, you’re gonna run offering and follow those countries laws instead of the US’ laws which are often more stringent. The third is Reg CF, just crowd funding regulation. This is a way to sell security to unaccredited investors. There’s a bunch of work you have to do to do it, filing a form with the SEC, doing a whole bunch of things. There’s a cap of 1.07 million dollars that you can fundraise. But a bunch of issuers have done this very successfully. The last, which has not yet been really effectively done, but I think will happen next year, is a Reg A Plus offering. I’m just gonna call them mini IPO. This is the way to sell to accredited or non-accredited investors up to a certain amount. The maximum is way higher, 50 or 75 million dollars depending on the type of offering you’re doing. With a bunch of requirements around ongoing reporting, and forms you need to file, but can effectively serve as a mini IP host. This is the four most common that we hear talked about, Reg D, Reg S, Reg CF and Reg A Plus.
Friederike: If you look at ICO’s that have taken part in the last couple of years, most of them went in compliance with these regulations. Given that many of them would be seen as a securities offering, they are in breach of many laws. The SEC, until earlier this year, the SEC was going mostly after projects that were scammy and were obviously scammy. This changed in November when the SEC made it public that they were going after Airfax and Paragon for issuing unregistered signature keys. What’s your take on this recent development?
Andy: Yeah, I think it’s a natural evolution of the space. Nothing in terms of what the SEC was saying, they had a right to. They had a right change when they did that. It was all consistent with what they’ve been saying for the last year. But what did change for the first time which you pointed out accurately is that they pursued what seems to be a non-fraud case for the first time. They pursued someone that they didn’t accuse a fraud, they just accused of selling unregistered security. That was the change that happened. But they’ve maintained that they’ve been allowed to do that for the past year. They just hadn’t really exercised that authority yet. I think that what they’re now saying is, okay, we now understand the space a little bit better. I think part of it is you have to consider their position, which is, the SEC’s job is to protect investors. They want, they capital formation to happen, they want fundraising to happen in the US. They’re not trying to kill the industry by any stretch of the imagination. But they do want to make sure that things happen legally and that investors are protected. What they did initially was, while they were getting to understand the space, they just knocked yet a bunch of really bad, obvious fraudsters and people that were putting investor money at risk. Then once they understood the space better, they were able to evaluate and say, okay, now we want to go after a few people that aren’t fraudsters, but are not following the laws and start to go after them. I think that’s just a natural progression. That will force more and more issuers to operate compliantly now they realize that it’s not just a fraudster that the SEC is going after. I think that was a big part of their objective there, was to put a flag in the ground and say, we’re now enforcing against non-fraudsters. You got to make sure you’re doing stuff under relevant securities laws and regulations.
Brian: Yeah, I mean on this topic we did do an episode a while ago of somebody who used to be at the SEC and do cases like that. The point he made also that what the SEC does is they tend to go after cases that are very clear, that they’re gonna win. Where they also have other things like fraud that they can accuse people of. So then when they’re in so much trouble, they don’t really mind, they won’t really fight the accusation of having done unlicensed security offering, and they can build like precedent of that, and then they can go to bigger projects that maybe haven’t done all these things illegally, and then have these cases to rely on.
Andy: Yeah, exactly. I think that’s a typical pattern for that where it’s kind of starting at the bottom end, and then going right to the middle of the spectrum of legality, and planting a flag there and starting to knock people down.
Friederike: Once you’re caught up in that as a project, can you take us through what happens? What do you actually have to do? You have to give back investments, or what’s the process?
Andy: Yeah, it’s a good question. I think a little bit unclear right now. But you can read the Airfox and Paragon enforcement actions and settlements, and see what they have to do. One of the things they have to do is offer rescission to investors. They can get their money back out. They have to file disclosures on a regular basis about their token, treat their token like a security. It’s just kind of like a bunch of clean-up steps that you have to do if that happens. I expect a lot of teams that start doing that proactively to avoid this. I think a scary thing for a lot of these projects is that you really have two risks. You’ve got the risk of the SEC comes after you and does something like this and file as an enforcement. You have to settle and follow a bunch of things that they set out for you. But you also are at risk of class action lawsuit by the investors. Actually, once the SEC does one of these enforcement actions, it sets up really nicely for investors to sue you, to think that who are following onto what the SEC said. I do think that there’s kind of a do all risk here for these issuers that did things poorly. They have to think about addressing both of those concerns. Addressing the regulators concerns, but also making sure that they won’t get in trouble with investor lawsuits in cleaning both sides of that up, I think is critical if you want to make sure you’re gonna have a smooth ride from thereon out.
Brian: Do you think these actions will kill many projects? Do you think this is something that, okay, there’s some cost, there’s some hassle, but it’s possible to actually come clean and comply with that?
Andy: That’s a good question. I think a lot of projects that could be subject to these types of actions, their systems are actually predicated on it being a non-security. If they have to treat it like the security, but the system might not just work. It could kill a lot of projects. But there are projects that were doomed to fail from the beginning if they were issuing something that was a security and treating it like a non-security. They were gonna get caught at some point. Someone was gonna file a lawsuit. The SEC was gonna come after them. I think a lot of projects will struggle and fail in the next couple of years. But also, again, I think there’s so many bad projects in the space, and bad actors, and people that didn’t think these things through. I think that’s natural. It’s a natural selection process that the projects that we’re doing things the right way are gonna succeed. Some of these projects, their premises were just impossible from the beginning, and fate is catching up to them at this point.
Friederike: One of the consequences from this SEC crackdown is that a lot of people who’ve been in the space a long time are proclaiming, at least, that the ICO is dead. Would you concur with that?
Andy: I wouldn’t. I would not concur with that. I think the hey day of everyone selling utility token, you know, sell me some Ether, I’ll sell you some tokens, my token does this, that, the other thing is over. People have to act compliantly. There may be cases where you can sell a non-security, or the token is able to be sold as a non-security and that’s awesome. I think a lot of security is offering. But at the end of the day, I think maybe this casual understanding of what ICO is, which was that like hey day, just unregulated, sending money back and forth is over. But the idea of a coin offering, or token sale, that’s not over. That’s sticking around forever. It’s just that the rules are being enforced a little bit more strongly now. We just have to follow that. I do not think the ICO is dead. But I do think what a lot of people understood to be an ICO is perhaps dead, and we got to shift our perspective a little bit.
Brian: On the one hand, certainly this unregulated ICOs have disappeared to a large extent, or diminish greatly. I think the regulatory thing has a lot to do with it. But even, it seems more compliant offerings are, the market overall seems to have deflated completely. What do you think it will take for that to come back?
Andy: I think in the early days of any market, it’s cyclical. I’m kind of a broken record on this, but I mean even just look at Bitcoin. If you’ve been in the space for a while, it’s not our fourth, our fifth, like 80% retracement of a Bitcoin’s price. It’s gonna happen. There was this ICO boom. Then the bottom kind of dropped out. What we saw is that all these bad projects stopped fundraising. But the good ones are still going. They’re still raising money and running token sales, public or private. We expect that to continue. I think a lot of the numbers that we saw in the past year or so, associated with the ICO market were inflated by the number of low quality projects that we’re able to just drag capital in. But the good projects are still going. I’m expecting 2019 to be a pretty calm year. I think we have this every couple of years in crypto where there’s not a massive boom, there’s not a massive bust, but people put their heads down and build. That’s what I’m expecting and hoping 2019 will be. I think at some point we’ll see the next run up when something happens, when there’s a catalyst. I’m not expecting that to happen in the next few months. But I certainly think it will happen at some point. It might be the rise of these profit tokens. It might be something totally unrelated that we haven’t talked about yet. But there will be something that will drive another hype cycle as we’ve seen over and over again in the crypto space at large.
Friederike: I would love to ask you to speculate about that a little bit more. Basically, until now you’ve drawn the distinction between good ICOs and bad ICOs. That’s not super specific. Are there certain areas in which you actually see the ICO coming back with much more force than in other areas?
Andy: Yeah, you know, there’s a bunch of ways to draw that line. A big one that I would draw is does the system need its own token or not? It feels like a massive percentage of the projects that we saw on the last couple of years just didn’t need their own token. I would put that in the bad ICO category. Where it just wasn’t necessary for the system to be successful. Then in the good ICO category, I think this is really important to know, just like startups, most good ICOs in my opinion are still going to fail. It’s really hard to build these things successfully. It’s not a sure thing that once you have a good concept, it’s gonna be successful. Even within the good ICO category, that’s a really hard market. It’s gonna be really challenging. A lot of them are gonna fail. Some of them will be massively successful, some will have middle success. Just like startups, there are a lot of great startup ideas that fail for a variety of reasons. That will happen within the good ICO category. But then that ICO category, I see them as just these two totally separate markets where the bad category was people saying, I’ve got an opportunity to go and try to run away with some cash here. Let me make up a reason for a token to exist, and sell it to people, and move on with my life. That’s the part that I think has really, really disappeared.
Brian: How do you see CoinList’s role evolving in the larger crypto space over the next decade?
Andy: Our goal is to support this ecosystem. We are picks and shovels for this ecosystem. You can even see that with the products we have today. Our first two products, that full sale, token sale manager product are about sales, they’re about capital formation whether that’s for value tokens or protocol tokens or profit tokens, or asset back tokens. We’re gonna help these issuers run successful sales. But our second two products, CoinList Airdrops and CoinList Build, are about building communities. Either kind of general communities with Airdrops, or developer focus communities with CoinList Build. That’s kind of the natural progression for us once you’ve run a sale, you need to build out your community and support your network. That’s what we’re gonna help with, too. Then we’re building out secondary trading venue, where there will be secondary liquidity. We just want to be start to finish, the place where issuers and investors go to do anything with a token network, buying, selling, primary, secondary, building community, participating community and be the one stop shop for all of that. Whatever the space needs, it feels like what it needed in the past year or so was help running effective compliant sales. What it feels like it needs now is help building community. Whatever it needs the next year is what we’ll do. But we are here to support the ecosystem.
Brian: So just one question on that. You mentioned a secondary markets. I presume you don’t mean like crypto exchange? Do you have in mind creating a market for let’s say SAFT before, like while they’re still security, and before the actual token is issued? What kind of markets are you thinking of creating?
Andy: I effectively do actually mean a crypto exchange to support the projects that run primary offerings in our platforms that they can have secondary liquidity on a secondary marketplace on our platform supporting other tokens, the one that are compliant then you could trade on. We’re working on building that out at a launch next year. I think SAFT’s an interesting case. Almost every SAFT, if you really dig into it, does not allow for secondary trading of the SAFT. There’s lots of it kind of happening out there, but it’s technically without permission of the company in almost every case. Less companies open up to that and are willing to have their SAFTs traded on a secondary market. I think that’s something we’re unlikely to support until those issuers are actually willing to open that app.
Friederike: Can I look back into one of the things you said earlier, you said you’ll help projects build a community. Building a community is actually super hard. If you think about how many communities each of us are going to belong to in the future, how do you envisage that? Do you think we’ll belong to a community more or less for every token we hold? Will we hold a lot of tokens that we’ll use for interaction with different gaps but not really be an active member of the community? Do you think tokens are going to merge with each other or take over? Basically in three years’ time, how many tokens will I have in my MetaMask, or browser extension for whatever usage it adapts?
Andy: That’s a very interesting, very hard question. I’m gonna answer the simpler part of that first, which is what communities will I belong to. I think I’ll belong to, deeply belong to a few communities for tokens I hold, and then kind of incidentally be in communities for other tokens I hold. Some of them, I’ll want to be building reference applications on their network and being really, really involved, and commit to being involved in that. In other, I won’t. I think it’s gonna be a lot in terms of the community side, like products I own today. I own this microphone I’m speaking into right now, but I’m not a big audio file, I wouldn’t consider myself to be in the microphone and audio equipment community, even though I do own this product. But there are a bunch of other products I own, a soccer ball, I’m definitely in the soccer community. I’m really committed to that. I think it’s gonna be the same thing for tokens where I’ll have tokens. Some of them, I’ll be really committed to the community. Others of them, I’ll just happen to have because I want to have it or need to have it. I don’t have a great answer for how many tokens we’re going to hold. I do think in the next few years, it’s likely that each person will be holding more tokens rather than less. It may be kind of abstracted away from me that I don’t necessarily have to worry about having this tokens. I think there’s a bunch of interesting products that are doing things around automatically exchanging tokens when I try and pay for something on a certain network. That’s interesting to me. But I think many of the kind of cross chain or interoperability solutions won’t have reach a massive adoption in the next few years. It’s more likely that we’ll have a bunch of individual tokens in our wallets to pay for things. But some of that may be abstracted away, and I may not need to think about keeping a supply of it. It might be that for example, I just need to have a bunch of Eth. When I try and use a service, then it automatically, this kind of on Eth exchange, it’s displayed to me, and it automatically swaps it out for that token. I pay with that. I’m not actually holding that token. These are a bunch of different options for that how can play out. But I think these interfaces and user experiences are kind of wildly underdeveloped right now. I’m really, really excited to see what hat ends up looking like in the next couple of years.
Friederike: If you’re saying that basically my wallet is just going to exchange the Eth I own automatically for whatever token I need, do you think in principle that token is then needed? Because if it is easily abstracted away by just owning Ether and paying in Ether, what good is a token that only does that?
Andy: Yeah, well first of all I should say that is just one of many worlds that we could find ourselves in. I’m not, I don’t have high conviction that that is the right answer. But I think it goes to different types of users on the system. When I’m talking about the automatic exchange, I see that as like a very casual user on the system. There will be people on the system that want to be dealing with kind of the bear metal all the time. I would use maybe like a file storage analogy of I use Dropbox to sort my files. Dropbox would be a nice interface and abstracts away a lot of the stuff that I have to deal with. But Dropbox might use Amazon S3 on the backend or their own servers. Just because I’m using Dropbox as a user, doesn’t mean that Amazon S3 doesn’t have to exist, and doesn’t have a purpose. There are lots of people that get value from using that really down to the metal, or not quite metal, the S3 level, but more deeply valuable and configurable service. In a lot of this cases, for certain types of users, the token might be abstracted away in a meaningful way. But for a certain set of power users, or industrial level users, professional level users, the token will be really important for the functioning of the system. I think just because end users aren’t using a token intentionally, doesn’t mean that that token doesn’t have a value on the system.
Brian: Cool, well, thanks so much for joining us today, Andy. It was great to catch up with you and hear about CoinList. Yeah, thanks so much for joining us.
Andy: Thanks for having me, really appreciate it.
Friederike: Yeah, super interesting talk.
Brian: Yeah, of course we’ll have links to lots of the things we talked about. There’s also lots of interesting blog post on the CoinList blog. Unfortunately we didn’t get to speak this time about, you wrote some interesting post about hostile network takeover, which is pretty fun. Hopefully we can revisit that at some point in the future.