Preston Pysh  01:20

Hey, everyone! Welcome to The Investor’s Podcast! I’m your host, Preston Pysh. I’m usually accompanied by my co-host, Stig Brodersen, but he was out in an event in LA and was unable to join us for this conversation. But with that said, I’m here with the one and only Caitlin Long.

Caitlyn, we are pumped to have you here with us. Welcome to The Investor’s Podcast!

Caitlin Long  01:40

Thanks! It’s really awesome to be on your show. I’ve been an admirer from a distance for a while. It’s nice to reconnect.

Preston Pysh  01:46

Likewise! You’re the go-to person when it comes to the laws and all this cool stuff happening around Bitcoin and just– holy mackerel!

I want to jump into this conversation, just right off the top rope, because I know we have thousands upon thousands of people that want to ask this question. So, I just want to put it right out there at the start of the show. It’s a very simple narrative. I can’t even tell you how many times I’ve heard people say this to me on Twitter, or when I talk to somebody about Bitcoin. This is the narrative that they say, “Well, you might be making a lot of money in the short term, but once it gets so big, the government is going to criminalize it, or they’re going to step in, and they’re going to ban an exchange. And then, the value is going to go down in a tremendous way.”

How do you, Caitlin Long, respond to that simple narrative?

Caitlin Long  02:41

Well, two ways. One is it’s not possible for a government ban on Bitcoin to be effective. That’s been proven so many times over. Even though there are some governments in the world, who do try to ban it, if it were to happen in a major country, such as the United States, what ultimately would happen is that it obviously would have an impact on the price. The regulatory risk is definitely a part of, I think, why the price doesn’t fully or necessarily reflect share value. But, I think to Plan B’s model, some of those risks are overestimated because Bitcoin would continue to operate.

The truth is, in the case of the US, if the government had wanted to ban it, the time to do it would have been 2012, or maybe 2013. The network effects are so wide and strong at this point, that even having the United States ban it doesn’t shut Bitcoin down. It just moves all of the activity elsewhere. I really doubt the US is going to ban it.

What is more likely is that the tax situation will continue to be very frustrating for all of us. In other words, every time we use crypto to pay for a cup of coffee, we’ve got to record it as a capital gain or loss. Also, the financial institutions that interact with crypto are going to obviously have to comply with some pretty strong regulations, as well. That would be the attack vector, I think. It’s regulation and tax, as opposed to an outright ban.

But I would just want to remind everybody who’s listening that even the internet…even if all the ISPs in the world were shut down, there are nodes are running on satellites. There are people, who do Bitcoin transactions on ham radio. There are definitely backups to the backups in the system, and it is really resilient. I think it’s, at this point, impossible to shut it down.

Preston Pysh  04:36

I can’t say I’ve had this much fun preparing for a podcast in a long time because this is really a field that is not my expertise, when you step into the legal framework of a lot of things. But one of the things that I discovered through the research was the definition of legal tender seems to be a really important definition to understand, when you start trying to understand the risks associated with the laws and how the governments are going to start viewing this. I’m kind of curious if you see it the same way. And more importantly, talk to us about this definition of legal tender.

Caitlin Long  05:16

Legal tender is a legal concept. It’s actually in the Constitution of the United States and in most countries’ constitutions, where the government defines that the government’s own issued currency is legal tender in payment of debts, and so it must be accepted within the country.

Interestingly, Trace Mayer has done a lot of work on the legal tender definition in the United States Constitution, which actually makes reference to gold and silver. And interestingly, a couple of the states within the United States, Wyoming being one of them, have adopted a recognition of gold and silver as legal tender because it is mentioned in the US Constitution Article I, Section 10, I believe. Basically, that’s where the government gives itself the power to tell everyone what money must be accepted within the borders.

There’s a concept though; a much broader concept of money in commercial law in the United States. So that’s where Wyoming, when we clarified the legal status of digital assets, which I’m sure we’re going to get into in a little bit, we mapped virtual currency to the same treatment as money. That’s not the same thing as saying it’s legal tender, to be clear, but it is treated the same as money under the law for the following purpose: When you take $1 bill in the United States, you take it free and clear of all so-called adverse claims against it. That is, if somebody had a lien against it, as long as you were not knowingly-defrauding the creditor, who had a lien against that dollar, it gets what’s called super-negotiability. Again, as long as you don’t knowingly-defraud someone, you take it free and clear even if it turns out there was a lien against it. You are deemed an innocent purchaser.

We have a concept of super-negotiability, an innocent purchaser concept, for securities that trade through securities intermediaries and for money. What Wyoming did was to say virtual currencies get that same treatment under the law in Wyoming. So, we did the second-best thing. We couldn’t make virtual currencies legal tender because the US Constitution says that only Congress has that power, and technically, it’s actually only gold and silver in the constitution that are legal tender. Which is interesting, because obviously, the dollar is neither, but I digress. We weren’t able to make virtual currency legal tender in Wyoming, but we did the next best thing, which is to give it the same recognition under the law from a negotiability perspective.

Preston Pysh  07:40

Yeah, it’s interesting. When I was doing some research, there was a lot of debate, specifically going into the coinage versus fiat or paper money in the US government’s ability to print paper money because it doesn’t specifically call that out in the Constitution. There’s been so much case law, it seems, that has occurred between then and now that has basically allowed that precedence to sit. I don’t know if you’re necessarily going to be able to argue any of that but, to be honest with you, I don’t know if it even really matters because I don’t think anybody’s trying to claim that Bitcoin will ever be legal tender.

Caitlin Long  08:15

Right.

Preston Pysh  08:15

And that’s perfectly fine. They can coexist with the dollar continuing to be legal tender and Bitcoin continuing to not be legal tender, and that still works, right?

Caitlin Long  08:27

Yeah, in fact, Nic Carter had a very interesting essay very recently about how the central banks don’t necessarily need to be as afraid as they might seem of crypto because if you look at what the stable coins have done overseas, for example, in Venezuela, to aid locals who are trying to get their hands on dollars. They do it through Bitcoin by a tether. We’re seeing some unusual paths if you will, but they are reinforcing, counterintuitively, the dollar as the world’s reserve currency. It was an interesting essay. I’d never thought of that angle before, but he’s right. We do not need Bitcoin to be deemed a legal tender in order for it to succeed.

Preston Pysh  09:13

So, how about the idea…? Because I think the next angle that people would look at this from is they’d say, “Well, in China, they ban the exchanges.” So you got that whole discussion point around banned exchanges, and, well, if the government wants to shut down Bitcoin, all they got to do is go to the exchanges. In the US, they could shut down the exchange. Talk to us about this narrative and your opinions on it.

Caitlin Long  09:35

Well, anything that restricts activity is going to have an impact on the price in the short term. Conversely, though, I really want to drive this point home: Anything that expands activity is likely to help the price. Because I do think that some things that can expand activity on the regulatory front. The US is very restrictive, as we know. Most other countries in the world, especially countries like Switzerland and Singapore, are very friendly to crypto assets. And so, the US, to the extent that its restrictions are lifted that could be a positive.

But back to your specific question, what if the exchanges are shut down? Again, most of the exchange activity in the world is not in the US. There are some pretty big exchanges that are based here obviously– Coinbase, Kraken, Bitrix, but the biggest ones in the world, aside from those, are not in the US. So basically, the gist is that the vast majority of exchange volume is taking place with companies that aren’t even serving Americans right now, because they’re not licensed to do so. So, to the extent that the US restrictions ever loosens up, there’s an opportunity to really open up the markets even wider than it already is.

Preston Pysh  10:46

What you’re effectively saying is if you’re a lawmaker, and you’re trying to put a law like that in place, you’re going to be combated with an army of experts that are saying, “Hey, listen. You’re just going to shoot yourself in the foot because all this business is just going to go somewhere else.” Is that your argument?

Caitlin Long  11:03

Well, yeah, but a lot of us have been doing that with politicians for years. In a lot of cases, it falls on deaf ears, but it doesn’t matter. You know, the market just goes right around these crazy restrictions that are put on by countries, when they try to block their citizens from having access to services that are available to others outside of their country borders. So, I just don’t think it makes a difference, right? The exchanges are going to continue to operate.

Would more restrictions on the exchanges generally have an impact on Americans’ ability to use crypto? Sure. But I think you’re going in the opposite direction. I think we’re actually seeing more companies become regulatory-compliant, and that’s where the activity is moving.

It’s not that the US is necessarily loosening up. Although, Hester Pierce’s proposal at the SEC was a very big step; to have a sitting SEC Commissioner start talking about safe harbors for things that might actually be deemed securities.

I doubt Bitcoin, at inception, would have been deemed a security, but there’s certainly an argument that it could have been. It certainly isn’t now, and the SEC has essentially admitted that, but there’s still some question with Ether as to whether it’s a security, right? It’s nice that the regulators are finally talking about safe harbors. There are things that I think are going to happen.

What we’ve done in Wyoming is to create the first bank charter that is going to be allowed to touch crypto in the United States. The FDIC does not want FDIC-insured banks to touch crypto. This is why we don’t have banks actively involved in this market.

If you look at Switzerland, for example, not only can they have custody over crypto through their trust powers, but they can actually hold crypto on the bank’s balance sheet. That is a lot farther than what Wyoming has done. But you know, the move that Wyoming has made, which is to allow the state-chartered banks to have custody over crypto through its trust department is a huge opening. No other bank in the United States is able to do that right now. So, I actually think that’s all positive. We’re going to be bringing more and more users into the market that heretofore haven’t been able to because they didn’t have a custodian available to them that’s a bank.

Preston Pysh  13:17

Do you think that they’re not allowing those FDIC-insured banks to handle it because they understand how, I don’t know if “vulnerable” is the right word, but how risky it is to actually take possession and not lose your private keys? Do you think that’s the reason why they’ve moved in that route to keep them separated?

Caitlin Long  13:36

Yeah, the banking industry in the US is very conservative, and the regulators don’t really have an incentive to take risks, so they’re definitely going to be slow movers.

No one’s ever publicly said this, but my read of the tea leaves is that the regulators in Washington are watching very closely what’s happening in Wyoming, and if it goes well, then that will actually pave the way to broader acceptance. But it’s going to take time. So, I think the vast majority of US banks, in other words, every bank that’s FDIC-insured are going to face the FDIC restriction for several more years. And the chartered banks in Wyoming are the only ones that can exist right now.

There will be other states, I think, that will try to do what Wyoming did, but there are a lot of very specific reasons why it’s very unlikely to work in other states. So, I think the Wyoming banks are where everybody should be watching because there’s an expansion of infrastructure that will solve problems that will be bringing solutions to the market that don’t currently exist right now.

One of the obvious ones is security token custody. There are custodians that provide security token services, but none of them are banks. Banks have special treatment under the securities laws. They can provide services that trust companies cannot, for example. For institutions who are required to deal with certain types of regulated financial institutions that, as of now, can’t provide those services, well, we’re about to get some that can, and that’s going to broaden the universe.

So, I’m less worried about a crackdown that closes off this market in the US than I am optimistic that actually, we’re seeing improvements in regulation. I happen to know what’s coming down the pike in Wyoming. You know, stay tuned.

Preston Pysh  15:26

I love it! So, let me ask you this: If you personally owned an exchange in Wyoming, and let’s say the federal government did do something crazy, and they say Bitcoin exchanges or crypto exchanges are banned, could they even enforce that based on the laws that exist in Wyoming?

Caitlin Long  15:47

Oh, that’s a good question. Because what’s been happening is existing crypto exchanges are looking to come into Wyoming. Could the Innova ones start up even if the SEC…yeah, I see, again, I don’t think they’re going to be banned. I think what’s going to happen is that the SEC is going to say, “Look, you’re an unlicensed broker-dealer. Go, get a broker-dealer license.” Or to be honest, the exchanges should be coming into Wyoming and getting a bank license because banks can handle securities. And without having a broker-dealer license, again, that’s why, again, stay tuned. Some of them are coming. From what I see happening, there’s not a movement to ban them. There’s a movement to get them regulated and bring them into the fold. That’s probably going to make some of the purists’ heads explode.

I really felt for Erik Voorhees, when I saw the headline about what happened to ShapeShift; losing so many of its customers when it started to apply AML and KYC. But that’s the price of being an operating financial institution in the United States. It just is. Whether we like it or not, it just is. As to the extent that we’re seeing some of the custodial exchanges, not ShapeShift because it’s non-custodial, but some of the custodial exchanges taking steps to become regulated, I think that’s a positive for the market overall. And again, for those that don’t want to deal with regulated exchanges, if you’re not an American, you don’t have to. There are plenty of alternatives that don’t deal with US customers.

Preston Pysh  17:13

So recently, just in the past week, we saw that Treasury Secretary Mnuchin had made the announcement that there’s going to be some sweeping regulation. There’s going to be some changes around how Bitcoin is handled. From what I gathered from the article, it had to do with the autonomy of basically mixing your coins, so that no one knows where they came from and where they’re going. Is that what your understanding of the sweeping regulations coming out of the Treasury are addressing? Or is there something else there that I’m missing?

Caitlin Long  17:44

The sweeping regulations, by the way, aren’t new. It’s just the specifics that are going to be new, but they’re not going to surprise anybody. I don’t think so. Because if you’ve been watching this space, there’s something called the travel rule, which essentially says that financial institutions within the United States, and frankly, it’s happening pretty much across the world. Anybody who wants to be part of the regulated financial markets is going to have to comply with the travel rule, which means that you’re not just knowing your customer, but you’re knowing where the customers money came from and where it’s going to.

And the crazy part about that, again, this is going to make people’s heads explode. It certainly does mine. It’s that financial institutions are now going to have to be sharing personally identifiable information with each other. In the case of crypto, they have to share that information before the crypto transaction because there’s no way to stop it after the transaction has taken place. So, you’ve now just created, because of these crazy regulations, data honeypots that hackers are going to be targeting.

By the way, this is all happening within the banking sector today, as well. A lot of the big hacks of big financial institutions are of people going after all this personally identifiable information that is not transmitted or stored in a truly secure form. The more of this personally identifiable information that the government requires financial institutions to collect and to share with each other, the less secure all of our personal information is. It’s just a fact. Unfortunately, these laws are the laws. They’re federal laws. I wish we could do something to change them. They have a tremendous cost.

If you really understood how the Bank Secrecy Act works, just the number of human beings, who have to review financial transactions that are suspicious. They’re required by law to have human review. It just adds a tremendous cost to being a regulated financial institution, but it is reality. There’s no way around it.

I personally think most of them are unconstitutional in their breadth and reach, and that they will be struck down probably over the next decade, but it’s not likely that that’s going to happen soon. So, anybody who wants to deal with a regulated crypto financial institution in the US has to comply with these laws. That’s black and white. You can’t stay in business in the US if you don’t comply with these laws.

All that said, I think the US crypto exchanges that deal with US customers are already complying with these laws. So, to the extent they come into Wyoming and get a bank license, that just helps them broaden their customer base and become more legitimate.

20:17

There was one other thing in the question that you asked that I wanted to hit. A lot of the companies in this industry pass missteps, and maybe they’ve been hacked before and never revealed it. We’re recording this show on the day that Binance went down for several hours, and it looks like there may have been a hack at Binance. We’ll see if that indeed is the case, but that’s what CoinDesk is reporting. And you know, the FCoin exchange just imploded a couple of days ago, and that was not a hack. That was just pure mismanagement that caused insolvency.

But here’s where I’m going: There may be others of those that are hidden out there that we just don’t know about. So, I actually think the other interesting angle here is the new players that are coming in with pristine balance sheets because they don’t have any history, and also, pristine compliance record. So, they don’t have the risk of the SEC or FinCEN or CFTC going after them for something they did a few years back.

That’s going to be interesting because, also, I think that elevates to the extent that they are regulated. The institutional investors like pension funds and endowments and foundations, which are not investing in this space right now, they can start coming in once they have those regulated partners that they can do business with.

Preston Pysh  21:30

So Caitlin, talk to us about Kyle Bass, and the way that he and some others that he worked with down there in Texas were able to prevent the federal government from confiscating physical gold. We all know the stories from the 1930s, when gold became illegal, and the federal government came in and basically usurped that gold out of the hands of the holders. Texas recently passed something that is preventing that from ever happening. Tell us the story, and then tell us how this might relate to Bitcoin or the cryptocurrency space legally.

That’s very interesting. I think it’s helpful to Texas that gold is mentioned as legal tender in the US Constitution Article 1, Section 10. That’s all very interesting. That’s another state that tends to have an independent streak like Wyoming. Texas is asserting its rights and because that’s legal tender, and that’s property, they’re saying the government can’t come in and confiscate it.

Caitlin Long  22:29

Wyoming actually did propose, and passed through our blockchain task force, a bill that would prohibit the judges in law enforcement situations, both civil and criminal, from compelling disclosure of private cryptographic keys. It was the original proposal. It didn’t make it through the legislature this year. It’s a budget session, and it needed a 60% vote to be introduced because it’s a non-budget bill. We’re going to end up bringing it back next year in a much stronger form, but that is essentially the same argument, where it’s saying that a court of law is not going to be allowed to compel disclosure of a private key. In other words, protecting someone’s crypto as a result.

The challenge, of course, is that you have to be able to compel someone to use their private key in a divorce settlement, or to give back stolen property, and the like. Those are the kinds of situations, where the court system can compel you to disgorge assets. Those are legitimate. I think even the hardest core libertarians would agree with that. The distinction that Wyoming is making here is that you’re not allowed to steal the asset. If you commit fraud, you’re not allowed to keep it. But, we are treating private keys as something different than the asset itself. As a result, you can be compelled to turn over the assets, but you’re not going to have to be compelled to turn over the private keys. We’re distinguishing them as very different than say, a password to an email account. It will come back at some point.

Preston Pysh  24:00

It almost sounds to me like you’re trying to redefine or upgrade the existing laws that specifically called out gold and silver, and you’re effectively trying to redefine it for the modern era. Is that what you’re doing in the way that you’re defining that?

Caitlin Long  24:16

Oh, absolutely. That is what we’re doing. If you look at the 13 laws that we actually did pass, and we’ve enacted already. That’s what we’ve done. We’ve updated existing statutes. In every case, except for one, they were, what I would call, enabling to digital assets. We basically defined the legal status of digital assets. We said they’re not subject to taxes. We allowed a financial sandbox for fintech companies to come into Wyoming, etc. We said utility tokens are not securities; therefore, not subject to state securities laws.

We’ve been very much enabling in our approach to the laws that we passed. And so, it is very much as you described. It’s designed to update the laws to reflect the fact that we have these new assets that don’t fit within existing legal regimes. That’s part of the confusion in the United States. In the tech world, people like to talk about tech debt. We’ve got this legacy cruft that’s weighing us down because it doesn’t actually reflect the way the world works anymore. Wyoming was the first to step up and modernize in a way that really reflects how cryptographic assets work.

Preston Pysh  25:28

From my vantage point, you guys just absolutely get it by not putting any type of tax on the gains there. I just can’t imagine the incentive that’s going to attract any crypto-based business to step into the state of Wyoming. So, where do you think we are at a federal level? Have you had any conversations with representatives, who may be viewing this from a similar optic that as we look with the United States competing globally in this space, are they trying to maybe adopt a similar point of view or law that would at least minimize the tax burden for capital gains?

Caitlin Long  26:09

Yeah, I sure wish that the federal government would be moving in the right direction, but I don’t have good news on that front. Don’t expect it to be. We can only do, from a tax perspective, what applies within the state of Wyoming. Obviously, the federal government is different. So in all of Wyoming, I’d still have to pay federal taxes. I just don’t have to pay state income property or sales taxes on crypto within the state of Wyoming.

So, yeah, there’s not much positive movement. I mean, Washington is just paralyzed. It’s really frustrating to me, watching what President Trump has done in deregulating so many other industries, and yet in the financial sector, he’s going in the opposite direction. He’s going in the wrong direction. I sure wish that he had someone that could bend his ear other than true Wall Streeters, and that’s who he’s got in his treasury department and economic team. So, it’s not obvious to me that anyone on his team really understands what’s going on here.

Preston Pysh  27:06

You know, it appears like Germany’s really kind of understanding of what’s going on. Didn’t they just implement something that didn’t have any type of tax burden for crypto in the whole country of Germany?

Caitlin Long  27:17

I don’t know about that. I do know that they adopted a crypto custody rule. Apparently, they had 40 companies within the first couple of weeks of January. Contact them to apply. I’m so not surprised, given what has happened in Wyoming. I’m so not surprised that that happened in Germany. There’s definitely a huge level of interest. That doesn’t mean that all the companies will make it through.

Man, I don’t know exactly what their licensing regime is. I suspect that it’s easier than the Wyoming licensing regime to get a bank because banks are at the top of the hierarchy in the US. You got money transmitters at the bottom. In your state of Alabama, I think it only takes a $5,000 bond to get a money transmission license, so you’re not putting up much capital. Money transmitters are the easiest and the lightest capital requirements. On top of that, you’ve got trust companies, which have more capital requirements and more regulations. And then, at the top of the hierarchy, you’ve got banks. And a subset of the banks is what we call the primary dealers. These are people who actually deal directly with the Fed and distribute US Treasury. So, that’s the city groups, the Bank of Americas of the world.

In that hierarchy, banks obviously have the higher capital requirements and regulatory burden, but they can do a lot more things than trust companies and money transmitters. I don’t know if in Germany, whether that hierarchy is the same. I suspect it is. But I just don’t know about the new custody law, whether that’s more equivalent to a trust company or a bank.

Preston Pysh  28:52

I assume you share the same opinion that I have, but correct me if I’m wrong. The stock-to-flow model is valid. And that moving forward in the next two years, we can expect a pretty aggressive price move due to the halving that’s about to happen here in May.

If that would play out, I think you have these primary dealers, who are sitting at the top of the food chain that are making money because they’re pretty much assured, based on the model that they have with the Federal Reserve. But they’re going to be looking at what’s happening in this market, and you’re going to probably see this thing go well above a $1 trillion market cap. It’s less than $200 today, in Bitcoin specifically.

So, with such an aggressive move, and such smaller banks participating or smaller entities participating in this and making ridiculous amounts of money in transactions, and just the sheer price movement of the underlying securities or commodities, or however you want to call it, at what point do you suspect them to say, “Hey, we want a piece of this,” and start coming into the full-scale legal framework because they’re wanting a piece of the pie, and they’re being forced to buy these, in real terms, negative-yielding bonds?

Caitlin Long  30:07

Yes, this is interesting. This goes back to when I was at Morgan Stanley still; debating how this is all going to play out. At the time, I thought that the mainstream financial sector was going to adopt this technology, eventually. I like how Jimmy Song describes it. His detour through enterprise blockchain, when he was at itBit for a little while. I was at an enterprise blockchain company for a little while as well, and I watched how hard it is to get the traditional financial sector to adopt these technologies. Whether they have a token associated with them, or they’re these private or federated blockchains that so many enterprise companies are working on. The result is the same. The mainstream sector is still shunning this.

I actually think that the biggest issue is that the settlement systems are so different. They do not have the technologies. They do not have the technological capabilities in-house to handle cryptographic assets. And so they’re, I think, going to stay pretty separate from where we are in the crypto sector. So, when I pivoted, I concluded that the real adoption is actually happening in the decentralized systems, and we’re building a whole new financial sector in parallel to the traditional financial sector. The interesting question is how many bridges are going to be built between the two? The more bridges that get built, frankly, the better off both of them are. But I think they’ll stay pretty separate.

You see JPMorgan in an announcement a couple of weeks ago that they’re spinning-off quorum to consensus. So, you see the big banks actually going the other way, and I’m not shocked, based on my experience. It’s just such a different world for them, and they don’t have the core skill set on their technology teams to handle it.

Preston Pysh  31:59

Yeah, it would be interesting to see how the equity ownership of those big banks would be potentially shifting or distributing their equity across both of those two camps if you will, and to see how much of that is changing over time. Because for me, I think in the past, the market cap had never been to a point that really anyone took seriously.

Caitlin Long  32:22

Yeah.

Preston Pysh  32:22

But on this next move, if you start going over $500 billion, or you go over a $1 trillion, …I think, at that point when it starts going over a $1 trillion,… and you’re already hearing the price of Bitcoin being discussed every single day on CNBC.

Caitlin Long  32:36

Right.

Preston Pysh  32:38

Four years ago, if you’d have a conversation with somebody [about this], they would just straight laugh at you saying, “Yeah, right. There’s no way this is going to be at a level where, globally, this could be a settlement currency.” But I think once you start getting up into those prices, all of a sudden, this really becomes a hot topic conversation. Now, it’s not just, “I knew a guy, who owned a bitcoin. They made a bunch of money, too.” Pretty much, you could talk to anybody in an office and everyone knows what you’re talking about at that point, and probably has a couple of people that had 100% or 1,000% or 10,000% return.

Caitlin Long  33:13

Oh, yeah. Stay tuned. There’s definitely a lot more institutional interest. The issue they’re all running into is custody. There’s a reason why the big custodians that handle institutional investors are banks. Since it gets back to what we talked about previously that we don’t have any banks that are allowed to have custody over crypto because the FDIC is standing in the way. And so, you’ve got to have a non-FDIC-insured bank that is going to be providing crypto custody, and that’s the Wyoming law. It’s a non-FDIC-insured state chartered bank that still has access to the Fed. I would argue that it’s even safer than a traditional bank because the Wyoming bank, since they’re not FDIC-insured, are required to hold 100% reserves. And so, you don’t have the classic counterparty credit risk.

Banks go bust, generally, because they either have bad loans, or they mismanaged their interest rate risk. A 100% reserve bank can’t do either because they can’t lend, and they can’t play the yield curve. They can’t mismatch their assets and liabilities, in other words. So, I would argue as a counterparty that it’s actually going to be safer. It’s going to be very interesting to see how institutions handle this. But I alluded to this earlier, there are things these banks can do that the market doesn’t have available right now.

For example, one: I’m going to go into the weeds now, but there’s something called a good control location that the SEC requires a custodian to have. And the SEC and FINRA have not clarified, but good control location is for a digital asset. Now, they only have jurisdiction over security, so we’re talking about security tokens here. It’s a pretty small market by market value, but pretty big opportunity over time.

One of the log jams that has kept that market pretty small by market value is that there isn’t a bank that can be a custodian. Why? Why are banks special? Because they have a safe harbor for a good control location. Until the SEC and FINRA define what good control location is, that means only a bank can provide it. But no banks can provide it, except for Wyoming banks. So, you see where I’m going. We’ve really found some very interesting angles to solve regulatory problems with the Wyoming law, and people are stepping up and using them. By the time this podcast is out, there will be news, based on what I know is in the pipeline in Wyoming.

35:30

There’s something else you and I talked about before. A lot of crypto companies are looking, but the Wyoming banking division has said they’ve had well over 100 inquiries, and there haven’t been that many that are going through the process. The interesting question for the crypto industry becomes, “Why?” We alluded to this earlier. We don’t know if the crypto counterparties we’re dealing with are solvent. There is no audit in most cases. There’s no proof of reserves. There’s no transparency. There’s a commingling of assets.

I was looking at one of the largest stable coins, one that is targeting the institutional market, and there is absolutely no ring-fencing of the cash backing the stable coin on that company’s balance sheet. There are some regulatory questions surrounding that company because of the history that it has. So, it’s an interesting question. “What happens if the regulators go after that cash? What happens to that stable coin because the cash is commingled, and it’s not bankruptcy remote? So, if one of those coins ever went bankrupt, how do the crypto holders get that cash?” Read their Terms of Service. Their Terms of Service allow the stable coin issuer to use your cash in any reasonable manner it sees fit or just some language to that effect. When an institution reads this kind of stuff, they look at it and say, “I can’t touch that with a 10-foot pole.”

As I was talking to one of my friends in the industry, the ability or the opportunity to professionalize this industry and to bring in the truly big money institutional investors that aren’t here yet, it’s like shooting fish in a barrel. There’s going to be so much opportunity for the players to come in and actually professionalize it.

Preston Pysh  37:12

You know, as you say all that, I’m just here smiling and shaking my head. The technology is moving so insanely fast that the regulatory side of it just did not even keep up. That’s how you’re getting the entrenchment that you have. I mean, I’m with you. There is just total absolute entrenchment. You have derivative stood up around this. It’s kind of mind-boggling to think how much infrastructure is set up around all these payment rails that I don’t know how anyone could think that they could shut this down at this point.

Caitlin Long  37:49

Oh, they can’t.

Preston Pysh  37:51

There’s just no way.

Caitlin Long  37:53

Yeah, they can try. But where I’m going is that the ones that come into Wyoming and voluntarily become regulated under Wyoming’s law that separates the proverbial men from the boys. Because Wyoming’s law requires 100% reserves on cash and prohibits rehypothecation. So, a lot of the crypto lenders outright disclose to you that they’re rehypothecating your assets; that means they’re fractionally reserved. You know that upfront, and so, you’re *inaudible* rolling the dice. If you have counterparty exposure to them, and they go down your loss severity is going to be pretty close to 100%. I would guess.

Preston Pysh  38:30

Yeah, and they’re not actually insured.

Caitlin Long  38:32

Of course not. Right. So, those firms are obviously doing, in some cases, extremely well. And the interesting question is: Will they ever be able to break into the institutional market?

As someone who used to be at risk of a fiduciary, ERISA is the highest standard of institutional asset management. ERISA fiduciary is a personal liability. I’ve been personally sued twice as an ERISA fiduciary for Morgan Stanley’s pension plan just because everybody on the committee got sued. But we have personal liability under ERISA, right? So if you’re an ERISA fiduciary, boy, you dot I’s and cross T’s. You’re going to start looking at the credit risk analysis of these institutions, and you’re going to look at their terms of service, and you’re going to say, “I’m staying away from this. I’m never touching this.”

Another example: fork policy. I was looking at one of the institutional players on their fork policy, and it said that they may or may not support forks, if any. So I read that, and I’m like, “What is this institution promising you?

Preston Pysh  39:30

That’s their own margin…

Caitlin Long  39:30

Exactly! There’s nothing legally enforceable in your contract with them.

Preston Pysh  39:34

Yeah.

Caitlin Long  39:35

Again, an institutional lawyer is going to laugh the way you did. I hope some of your listeners actually take the time to go look at the Terms of Service of their counterparties because you’re going to see this stuff.

Another major “institutional” player: You know how they define Bitcoin? They serve Bitcoin only. In their contract, they define Bitcoin as “a digital asset”. Okay, again, you can drive a Mack Truck through that. What is it? They are promising you nothing.

In Wyoming, in the Terms of Service, you are required to, for example: define the asset that you are handling by reference to the source code version on GitHub. And so if the asset forks, like the old Ethereum Classic (ETC) fork, where the new fork became the accepted asset; in that instance, if somebody was custody in ETC, they are not allowed to just change the asset to the new ETH without getting expressed approval from the customer because the customer had a property right in that original ETC. They’re not obligated to continue to service it if they don’t want to, so they can give it back to the customer. But they cannot just magically say, “Oh, well ETH is now new ETH, not old ETH,” and just change the terms because that is actually theft of property if they do that. If the problem is you’re dealing with an institution that defines Bitcoin as, “a digital asset”, you’re never going to win a lawsuit against them because they’re not promising you anything enforceable.

Preston Pysh  41:11

Yeah.

Caitlin Long  41:11

Exactly. Again, as my friend said, it’s like shooting fish in a barrel to professionalize this industry. I’m wildly optimistic about the opportunities for the companies that are going to come in and step up and comply with those standards. There will be some. There have been some publicly named that’s hanging around that I actually met one last night that’s not been publicly named. It’s a huge company in this industry looking at coming into Wyoming. There will be some existing players, but as we were chatting before we started the podcast. I think a lot of the incumbents can’t comply with those rules because they’ve done so much fast and loose. They didn’t have to comply with any rules in the early days.

Preston Pysh  41:51

No competition.

Caitlin Long  41:51

To try to actually backfill and comply with strict rules like that, they just can’t. And so, when we look back three to five years from now, we’re going to see, truly, that the best companies in the industry are in Wyoming complying with those very strict rules. And it just simply means that they’re solvent. They’re not allowed to become insolvent and play fast and loose like everybody else frankly is. We just don’t know who’s insolvent and who’s not. We don’t know where the next FCoin is nor when the next Binance hack is.

Preston Pysh  42:23

One of the things that I really took away from a conversation that I listened with you, Trace, and Tyler out there in Wyoming was this idea of states’ rights versus federal law, and how this interchange between both of them really take place, and where Trace was mentioning how he feels like there’s so much power down at the state level.

Caitlin Long  42:46

Yup.

Preston Pysh  42:47

I think an example that so many people can understand so easily right now is for years there was no legalization of marijuana. Then out of nowhere, it seemed like these states were starting to bump their chests and say, “Hey, we’re declaring that marijuana is legal in the state of Colorado. It’s legal in California.” Do you feel like there’s something similar taking place with respect to how Bitcoin and crypto assets are being viewed from a states’ rights standpoint in the face of the federal government?

Caitlin Long  43:17

Oh, yeah. If you look at the Rocky Mountain states, they’re the ones that are actually taking the lead on this. It’s not the coastal states. I think we’ve had now 12 states pass the utility token bill that Wyoming originally passed. And it’s basically Wyoming and pretty much all the states surrounding it that have passed it, which is awesome. It’s not one political party or the other. At East Denver, we had a very conservative Wyoming governor with a very liberal Colorado governor on the same panel vehemently agreeing that we should be attracting crypto.

[Going back to] your earlier question. The United States is a republic. We are not actually a democracy. We are a Republican, in which the states are the sovereign unit within the government. We tend to forget that a lot, but the US Constitution defines the powers for the federal government, and all of the powers are reserved to the states. That concept has been eroded substantially by the Supreme Court in a lot of cases that I think were wrongly decided, but the concept is still there. The states have the vast majority of the political power in the United States, and the biggest piece of that is what’s called the Uniform Commercial Code.

All commerce is governed by state law. There may be portions of federal law, where federal regulations preempt for various reasons, but the basic commerce that governs every transaction that every one of us does every day is actually state law. And so, the states have enormous power, and that’s what we stepped up to and recognized in part with what Wyoming did with its regulations.

Preston Pysh  44:51

With that said, I think this is under Article I, Section 8 of the Constitution. There’s a very specific portion that calls out the regulation of interstate commerce. Do you see any vulnerabilities with interstate commerce and how the federal government could come down and start regulating things inside of, let’s call it, Wyoming due to that clause being in the Constitution?

Caitlin Long  45:13

Yeah, that’s the truck that’s been driven through the federalism concept in the US Constitution; it’s the interstate commerce clause. It has been a kitchen sink of federal powers that have been implied into that. I was specifically alluding to that when I said a lot of those Supreme Court cases I think were wrongly decided. But that said, in the crypto industry, it’s clear that the federal government has jurisdiction over securities. That is settled law, but it doesn’t have jurisdiction over property.

So, if you try to figure out, “Where do digital assets fit?” Digital securities are clearly securities. That’s obvious. Virtual currencies are not, so what are they? This is where we mapped it to money. And then for the utility tokens that are not securities, we created a new class of property, called digital consumer assets. These things don’t fit very clearly within the law. It’s also true that there’s going to be a skirmish over where these assets are “located”. Again, only lawyers would dance on the head of a pin and argue where is data located, but actually, the accountants are doing the same thing. They’re settling on the location of the private key as where the asset is located. But frankly, you could memorize your seed phrase and walk across a border, and the asset literally moves. So, it’s going to be interesting to see if that remains the case or not.

I saw Drew Hinkes tonight tweeting about a very interesting case, where the argument was about local bitcoins, and because the servers are all over the world, is that considered interstate commerce? Or, because it was a peer-to-peer transaction that took place, where two people were physically present in the same place, is that the jurisdiction? In which case, there was no interstate commerce because they were literally in the same place. This is going to be an area that’s going to be fought out among judges. Wyoming has done everything we can to broadly define how you locate an asset in Wyoming for commercial law purposes, but it also is worth stating that the answer may be different for criminal law purposes. We may actually have broader federal jurisdiction under criminal laws than we do under commercial laws, where the laws will ultimately be controlled by the states.

Preston Pysh  47:33

And two people can memorize a private key.

Caitlin Long  47:37

Absolutely. You bet! Yeah, these are thorny issues.

Actually, I was invited to participate in a group called the Uniform Law Commission. They originally attacked Wyoming for what we were doing, and surprisingly, they’ve come full circle to recognizing that Wyoming actually was getting this right. We may not have gotten a perfect, but I think the 50-state group that is rethinking all this is moving in the right direction. They’re moving toward Wyoming. But there’s going to be a specific working group session in May to discuss this whole question of where are digital assets located?

The accountants are definitely moving at least in an enterprise context to the question of, “Where’s the HSM, the hardware security module?” or, “Where’s your flash drive that has your private keys on it?” If it’s located in some place, then that’s where the asset is located. And if it’s multi-signature and it’s located all over the place, then where is the decision authority around the assets? That’s how they define where it’s located.

The reason why that question even has to be answered is when you’re dealing with enterprises, they have to disclose where their assets are, and their auditors have to know where they are, and they have to pay taxes in those jurisdictions. So, as much as that may make you uncomfortable, on the flip side, you can actually optimize for where those assets are located. You can and everyone does look for welcoming regulatory regimes to make sure that the business that they’re doing wherever they are is actually lawful. It’s not difficult to make sure that your servers are in a particular place if you want them to be, for example.

Preston Pysh  49:15

Real fast on the mixing discussion, how do you see this playing out as the most likely form moving forward? I just look at it from a tax implication standpoint, and I can understand why pretty much any sovereign state would have a real issue with the mixing of coins, so that no one knows who owns the public address at that point. How do you see it playing out moving forward?

Caitlin Long  49:40

I think we’ll have two markets. I think we’ll have mixed markets and regulated markets. And I think that they’re not going to clash enough that coins become non-fungible. But again, this travel rule makes it very difficult for the regulated financial institutions to deal with mixers unless they’re mixing themselves. And so, I’m not an expert on this. I need to dig into it, and it’s going to be playing out in the next couple of months as we see these new regulations, but we generally know what is going to happen. You have to know who the counterparties are. That doesn’t mean you can’t use mixers to ensure that the transactions remain private. There’s an enormous amount of privacy around Wall Street firms’ trading strategies, and yet their financial institutions know exactly who they are. There’s a difference between privacy and anonymity. So I think you will always have the dark markets that stay out of the regulated financial institutions, and Godspeed that those exist.

I was reading recently something on the order of 20% to 25% of both Bitcoin and Ether are self-custody. They’re not actually held on financial institutions’ books, so people are heeding the “Not your keys, not your coins” advice. I love that there is a parallel market. We have a choice to take our assets off these counterparties’ balance sheets, put them on our own, and be self-sovereign. But if we choose, we can keep them out of intermediary. If you’re at an intermediary, that means you’re in the regulated market almost certainly, especially in the US. Because even the exchanges that don’t have a bank license or a broker-dealer license, they all have to comply with FinCen. And it’s frustrating.

I saw a Twitter argument, I think it was Paxos, who was flagging that transactions were being sent to a Wasabi Wallet. They were asking for more information from the customer, and the customer was getting upset. I would advise that when an exchange has to talk to a customer like that, they should explain that it’s not their choice. They have to apply the law in order to remain in business, and it’s their obligation. Don’t be angry at the company. Be angry at the government for putting that law in place in the first place. It’s like everyone getting mad at airlines for all the crazy policies, but in almost all circumstances, those policies were not the airline’s choice. So, we’ve definitely got that situation. But you should expect that if you’re dealing with an institution that you’re not going to be able to CoinJoin, the institutions are going to have to do all that: know your customer, anti-money laundering, and counterterrorism financing analysis.

Preston Pysh  52:27

So, if I was a person that was listening to this conversation, and I had no idea who you were before listening to this, I’d be asking myself, “All right, where can I follow this person on Twitter immediately?” And so, I guess my question for you is: “Who are two or three other people that you look at with that same lens of, “Holy moly! I have to follow this person,” from a legal standpoint, with respect to crypto-assets, that you think is at the top of the game and is really understanding of where all of this is going, and is somebody that you just couldn’t stand without having in your Rolodex of people that you follow?

Caitlin Long  53:04

I’m going to end up leaving people off, so I’ll start with an apology because there are so many that are really terrific. But I will say, one who I checked regularly is Drew Hinkes. He is so on top of breaking news related to crypto litigation, and also related to new proposed laws, both at the federal and state level. He’s just got a great thread. Actually, I’m going to stop there. Well, I would add Catherine Wu just because every time regulations come out, her annotations are just amazing! She’s an absolute star! For entertainment value, much less the explanation. They’re spectacular.

I’m going to end up making so many people mad if I keep going, so I’ll just highlight those two. I think most people in the legal community would concur calling them out for their analysis in each of those respective ways. Everybody’s following them for those reasons.

Preston Pysh  54:03

Okay, so this is my last question: “What do you think a lot of people in this space, or even people that aren’t in this space, are missing right now?

Caitlin Long  54:11

I think it’s the counterparty risk in the institutions. We are going to see a big separation. There’s a push towards proof of reserves. There have been a lot of conversations about crypto in Twitter and Reddit forums. Customers are starting to get upset that there’s no transparency in their crypto exchanges. Some of these companies are now five to six years old, and they’re not audited. Why? Why aren’t they publishing audited financial statements? Why don’t we have proof of reserves in, at least, Bitcoin? I recognize that at some point, it’s difficult to do. But we have no idea how to do counterparty credit risk analysis on these exchanges and lenders and custodians. And all of them, if they’ve been in business for a while, have a history.

Again, the ones that actually do get licensed by coming into Wyoming and voluntarily submitting to the regulation that they have 100% reserves. It’s not as high in at least the developers’ minds, or not as valuable as actually having proof of reserves, but it’s not nothing. It’s going to be quite a statement, I think. So, stay tuned. You’ll see who comes into Wyoming, and I think once they voluntarily comply with those regulations, that’s separating the proverbial men from the boys.

Preston Pysh  55:25

Caitlin, I cannot thank you enough for this conversation. I have learned so much. I am such a big fan of yours. If people that are listening to this want to learn more about you, where can they find you?

Caitlin Long  55:37

On Twitter, @CaitlinLong_. I also publish pretty regularly on LinkedIn and Forbes.com.

Preston Pysh  55:44

Okay. We’ll have links to all those locations for people if they want to check it out. Thanks for coming on The Investor’s Podcast.

Caitlin Long  55:51

Yeah, thank you! Great to talk to you. I really enjoyed it, too.

Preston Pysh  55:55

All right, everybody. Thanks for listening to the show. If you guys enjoyed this one, make sure you share it with your friends. And with that, we’ll see everyone next week.

Outro  56:02

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