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SF Blockchain Week: SEC Subpoenas Hit Crypto Industry

Blockchain Capital’s Bart Stephens discusses experimenting without safe harbour, SEC exodus, and NFTs as the killer dApp

by Martine Paris, U.S. Tech Reporter, The FinTech Times

“If 2017 was a raging party, then 2018 is the hangover,” laughed Blockchain Capital’s Bart Stephens as he addressed the Back to the Crypto Future conference during SF Blockchain Week. “You can’t have an asset class go up 20 to 30 times, like in the case of Bitcoin and Ethereum, and not have some sort of retrace. It’s the nature of capital formation and speculation.”

(Blockchain Capital’s Bart Stephens)

”What we saw last year was that the Ethereum ERC20 standard really captured the imagination of both investors and entrepreneurs worldwide where with just two lines of code you could create your own crypto assets, whether it was a utility token or a security token. Whether the category of utility token even exists in the eyes of the SEC, we saw $18 billion of capital being raised with a kind of Kickstarter on steroids. It proved Ethereum as a platform for global crowdsourcing,” said Stephens commenting that ICOs made it possible for entrepreneurs to bypass Sand Hill Road to raise capital from traditional VCs.

“It’s a challenging time if you’re an entrepreneur or investor right now, primarily due to acute regulatory uncertainty. There’s no path forward if you’re a token issuer. If you touch the U.S. in anyway, it’s a contagion that can turn your token into a security. It’s a frustrating environment.”

“There’s a tremendous amount of innovation happening here. Some of the largest market cap companies and projects are based in San Francisco including Coinbase, Ripple, Coinlist, Kraken. It’s important for regulators to recognise that this is a global phenomenon. The markets of China, Korea and Japan are incredibly important. From a regulatory point of view, the U.S. is offshoring innovation. They’re saying the U.S. is closed for business, go to Malta, go to Singapore, go to Switzerland.”

Referencing Ripple’s Swell 2018 conference last week in which former U.S. President Bill Clinton delivered the opening keynote, Stephens said with the birth of the internet in the 1990s, the Clinton Administration took a hands off approach to let innovation flourish. “Federal regulatory entities like the FTC, FCC and even the IRS said no sales tax on your Amazon order, thus giving entrepreneurs and venture capitalists the rules of the road.”

“When you know the rules of the road, the magic of U.S. capitalism can happen which is the efficient allocation of capital to the world’s most promising entrepreneurs.” Stephens said, “That is no longer happening here. The crypto industry has been dangerously naive over last three years and have assumed U.S. regulators have a balanced approach to innovation on one side and consumer protection on the other. Things have changed markedly in the last six months. There are hundreds of subpoenas out in the crypto industry right now. This is not well known. Whether they’re exchanges, or law firms, or investors and ICOs, startup companies as little as three people. What we’re seeing as a result is capital formation is freezing.”

“It’s very unclear how a protocol would conduct a public sale of a utility token to U.S. investors. There’s no guidance from appropriate regulatory authorities on that. The SEC is applying laws that are on the books which were written in 1933, 1934 and 1940. Crypto assets are a new asset class and ill-equipped to be dealt with security laws that are getting close to nearly 100 years old. It’s hard to look out two or three years because things are getting worse for U.S. entrepreneurs and investors, not better.”

As for larger economies, Stephens added, “Singapore and Switzerland for sure are giving clearer rules to the road. They’re saying if you do XYZ then you are a non-security token, and here’s the regulatory regime you need to do to sell your tokens in an ICO process to residents in Switzerland vs. residents in the rest of the world. We don’t have that from our regulatory authorities, namely the SEC, but by the way, there are nine regulators that claim jurisdiction over crypto. Department of Justice is involved. Department of Treasury is involved. Federal Reserve, SEC, CFTC, IRS, FINRA and that’s not even including the state regulators like the New York State Attorney General that has sweeping powers in the financial services industry. So if you’re two kids out of Stanford with an awesome protocol idea or utility token, good luck navigating through those nine regulators not including the states where money transmission laws are different in all 50 states.”

“We need to take a holistic approach to fostering innovation that recognises that this is a new decentralised technology that’s global. Writing legislation that is better crafted and not 89 years old. Provide a safe harbour for entrepreneurs who are trying to innovate.”

SEC speaks

(Scott Walker of the SEC at Back To the Crypto Future)
The SEC was also at the Back To The Crypto Future Conference with Scott Walker on the opening panel discussing the SEC mandate to balance capital formation and efficient markets with investor protection.
For guidance, he directed the audience to SEC Director Bill Hinman’s remarks on applying the Howey Test, CryptoMom Hester Pierce‘s’ dissenting opinion in support of an ETF that would give retail investors access to bitcoin, and newly appointed Crypto Czar Valerie Szczepanik, who oversees ICOs. Watch Scott Walker’s remarks on the live-stream at


Will the ETF happen?

I had a chance to interview Stephens on the question of whether the ETF would happen this year. He responded, “Time and time again the SEC has turned down ETFs, I don’t see any reason for them to change at this moment. I wish they would. We think there’s enough market surveillance and infrastructure in place. The markets are large enough that this would be a good thing to add investor protection which is one of the primary mandates of the SEC. We hope they’re open-minded but we’re not terribly constructive on the possibility of an approval.” I asked if the ETF doesn’t pass, will Bitcoin drop to $2,000. He said, “I don’t think so. I think SEC continually rejecting ETFs have been priced into the markets at this point and so I don’t think that will effect the price of Bitcoin.”

Blockchain Capital’s portfolio

Blockchain Capital has been financing startups in the blockchain and crypto ecosystem for over five years. They have four venture funds and have invested in over 77 companies. Portfolio includes BitFuryBitPesaBlock.OneCoinbaseHarborKrakenMessariOrchid, and Ripple.

Having reviewed over 3,500 deals since their 2013 launch, 200 business plans each month, Stephens said that for 90%, blockchain is not a good application. He explained, “Blockchains are essentially a new data architecture. They’re a distributed and decentralised database where data is replicated over hundreds of thousands of nodes. That is costly and inefficient. You only need blockchain technology if you are trying to ensure there isn’t tampering with a given data set or a given value transfer. Bitcoin has a proven use case for a Gold 2.0, or a Paypal 2.0 in which Bitcoin Cash was the first Bitcoin hard fork. Ethereum has proven itself as Kickstarter 2.0 or NASDAQ 2.0. A lot of these other blockchains are building interesting technology whether it’s EOS or Telegram or Dfinity but what we haven’t seen a lot of are these things live and in the wild yet. What we haven’t seen is their organic, unmet demand on the customer side, and because blockchains are expensive and because the data set is redundant and replicated, you have to have a good reason for having tamper resistance. You need to ask yourself if you’re an entrepreneur, does an Oracle database work okay because if so you should go with the Oracle database because it’s much cheaper. If the answer is no because you really need to ensure the veracity of a wide data set or transaction like title transfer in an untrusted environment, than blockchain is a good solution for you, but just tacking blockchain onto your business plan won’t get you an investment from an investor with domain expertise. Those days are gone.”

I asked Stephens what he was most excited about in the crypto space. He responded that there are three sub-sectors:

1. Non-Fungible Tokens
2. Decentralised Exchanges
3. Security tokens.

He told the panel, “We remain excited about tokenised technology. We actually tokenised our third venture fund. We did an ICO and raised $10 million in our third venture fund. We took something that was previously illiquid as a private equity fund and made it liquid by fractionalising it and tokenising it. We created the world’s first security token.”

“Securitize and Harbor are looking at doing the same with illiquid asset class of real estate, which is the largest single asset class in the world. If you’re an entrepreneur in blockchain technology, or thinking about an ICO or creating a token, if it’s enabling you to do something the world has never seen before, you’re probably in the right spot. If a regular database will do just do fine, and you’re just adding a token for fundraising, you’re very likely adding friction to the customer experience. We call this a friction token. If you’re making someone buy a token just to get your product or service and there’s not a good reason for it to be decentralised or it’s not operating in a non-trusted environment, you very likely have a friction token which is a very tough experience for users. We don’t have to go buy Starbuck tokens to buy Starbucks. If that is the assumption you’re making that users will use hundreds of hundreds of tokens to use different services that work just fine like buying coffee, you’re probably barking up the wrong tree as an entrepreneur. These are good questions to ask yourself.”

NFTs Are The Killer dApp

“One of the areas that we are seeing organic demand in startup activity and end user activity is the intersection of video games and crypto — non-fungible tokens. We have an investment in OpenSea, a marketplace for video game assets. If you play a game like World of Warcraft or Second Life, there are tens of millions, and if you include Asia, over a hundred million users that live and play in these virtual worlds with virtual economies and virtual currencies, and you can have virtual objects, but at the end of the day until this year, all of those objects weren’t owned by you. You might have spent a year of your life getting some super special fire sword but it turns out that in World of Warcraft you don’t own that fire sword. Blizzard Entertainment owned by Activision, a public company, owns that fire sword. So if you try to sell it for U.S. dollars, you are out of luck as a gamer. That is changing now. Persistent worlds, even casual games you can earn something in game slaying a dragon and get a magical coat of armour, you can pull that out of the game, go to OpenSea and sell it for Bitcoin, and go to Coinbase and sell your Bitcoin for U.S. Dollars.”

“CryptoKitties was the first example. There will be many more games that capture the notion that gamers own the experience and work product and results of some endeavour online. So that is an area where we’re actually seeing an organic demand environment unlike some of the other areas which are still early stage like enterprise adoption, still at the proof of concept stage.”

Trust and Privacy

“Why did Satoshi create Bitcoin and blockchain technology ten years ago?” Stephens asked. “Well, because in 2008 the global financial system failed us in a galactic way. We had trillions in bailouts and $15 trillion in money printing. Satoshi said what if we could create a system where you don’t have to trust the centre counter-party to execute transactions. What if you could put in a proof of work system that aligned people’s incentives in an elegant way to form a consensus to allow a transfer of value between two entities. Incumbents incapable of protecting the system they created, had became too interconnected and leveraged.”

“If you’re using Facebook, Instagram and Google and you think they’re products are cool and you haven’t paid for them. It means your privacy is the product. They’re selling that to advertisers. Now we find out that the Russians and Chinese also have your data. We’re going to see a similar moment somewhere in time where blockchain technology is potentially an answer to the large, centralised monopolies that dominate life on line — Amazon, Apple, Facebook, Google. Decentralised approaches to centralised trust problems are the promise of blockchain technology. These are hard problems to solve and incumbents don’t go away easily, that’s why Jamie Dimon really hates Bitcoin. Dimon sees it as an existential threat to his business, and that’s why we’re seeing deafening silence from Facebook and Google in terms of blockchain technology. If you have a monopoly you just be quiet and cash the checks, you don’t want to rock the boat. And so a lot of these technologies whether we’re talking about ICO technologies or blockchain technology are incredibly disruptive from the status quo so the maintainers of the status quo are going to fight like hell to keep their advantage.”


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