Only the Ultra-Wealthy Have Access to Baby Unicorns; Tokenization Fixes This
Hello Defiers! Cryptocurrencies challenge the incumbent financial system, by design. Distributed ledgers and their cryptographic tokens are built to transfer value with no interference from third parties. It’s a peaceful revolution, but a revolution noneth...
Hello Defiers! Cryptocurrencies challenge the incumbent financial system, by design. Distributed ledgers and their cryptographic tokens are built to transfer value with no interference from third parties. It’s a peaceful revolution, but a revolution nonetheless. That’s why many crypto enthusiasts are quick to ignore and deride regulations; this new system was built to sustain attacks and censorship, potentially from these very officials.
Kendrick Nguyen co-founder f Republic, an investment platform that enables everyone to invest in startups, understands this sentiment. When his family moved from Vietnam to California’s Bay Area, he saw that wealth inequality was being perpetuated by legislation which only allowed millionaires —aka, accredited investors— to invest in high-growth tech companies. That prevented the less well-off from owning pieces of the companies that would go on to change the world and benefit from the huge amounts of value they created.
Nguyen, who spent his early career as a securities lawyer, then as a Stanford Law Fellow, and later as General Counsel at AngelList, believes tokenization can help bridge that gap. Tokens can reduce inequality by allowing everyone to invest in startups at the cutting edge of their industries. But, he also believes there’s no reason to do this at the margin of the law. Nguyen argues if crypto plays by the rules, everyone will benefit.
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Tokenization is the Great Investment Equalizer
By Kendrick Nguyen, Co-Founder and CEO of Republic
Scrappy founders have thrived in recent years with startups that aim to address some of the systemic unfairness of legacy economic systems. The most exciting of these have incorporated cryptocurrency tokens to write an ethos of access and opportunity into their code itself, giving rise to the maxim “code is law.” From a technical perspective this is true: encoding the rules and responsibilities governing a security removes the need to trust in other people, who are capable of error or malfeasance. Eliminating this weakness is a major rationale behind cryptocurrency development.
But this approach misses a major truth: code is not law. I learned this from my time as a securities attorney and an academic at Stanford Law School. Regulations define the parameters of the private markets and mandate behaviors and prohibitions to protect investors’ interest. Transactions involving more at-risk or less sophisticated participants are more strictly governed. And no innovation in finance can be long-lasting if regulations are flouted and governmental relations ignored. There is no better example of this than the short-lived ICO boom of 2016-2017.
Many blockchain projects boldly ignored regulatory compliance altogether when offering their tokens to non-accredited US investors, resulting in costly legal consequences down the road, as in the case of Telegram. And many in the crypto space feel that any acknowledgment of regulations’ legitimacy —especially those that regard tokens as securities, not utilities— is a surrender to an unacceptable status quo.
That’s unfortunate. Like it or not, the definition of a security applies to tokens as much as other instruments. That’s why it’s crucial to understand and optimize the legal side of the equation if we want to see successful, widespread tokenization.
Securities laws, in spite of their shortcomings, exist for very good reasons: to regulate the fair exchange of units of ownership, to protect individuals from fraud or exploitation, and to identify bad actors and hold them accountable. In many cases, these laws should and do apply to tokens. It’s true that blockchains offer powerful new ways to provide safeguards and benefits to large numbers of investors. But at bottom, where they still represent a stake in the winnings of a for-profit enterprise, it is entirely appropriate for them to be subject to securities law.
Nor are regulators the immovable luddites some technologists paint them to be. The truth is that understanding the legal basis of, and justifications for, rules that govern securities is essential to creating the regulatory environment that allows tokenized projects to flourish.
When my family immigrated from Vietnam to the Bay Area, I grew up next door to the glittering wealth of the tech industry but, like most people in Silicon Valley, as an outsider and not a participant. I didn’t know then that such a barrier was a by-product of well-intentioned laws.
From the Great Depression of the 1930s to 2016, US securities regulations only permitted millionaires —also known as accredited investors— to invest in private securities, which were deemed too risky for those less wealthy (and falsely, by insinuation, less sophisticated). In other words, only those who were already wealthy were allowed to invest early in Google, Apple or Uber before they went public. That broad stroke unfortunately resulted in the 99% getting shut out of high-quality private investment opportunities in tech in the past 80 years, perpetuating existing wealth inequalities.
The fact that only the ultra-wealthy had the access required to invest in baby unicorns at their early stages created a closed loop that left most people out. I never lost the memory of my teenage self wishing I could invest early in Amazon and Google. And I saw the potential for a more accessible and inclusive world of venture capital.
From 2011-2013, AngelList and other market participants convinced Congress and the Obama Administration to enact the JOBS Act, which since 2016 has permitted anyone, regardless of their income or net worth, to invest in private companies offering securities in compliance with Regulation Crowdfunding or Regulation A.
When people first started exploring tokenized ways for investors of all income brackets to share in the wealth created by startup growth, many assumed that, as most tokens are deemed to be securities under US laws, they would be unavailable to non-accredited investors. This resulted in a lack of participation and adoption by the masses.
But these analyses were premature. In reality, it is absolutely possible to facilitate non-accredited investments in traditional and digital securities —specifically, through Regulations CF and A, possibly along with certain pre-existing private exemptions. In fact, these rules have already been used to enable compliant token distribution, airdrops and sharedrops to both accredited and non-accredited participants. They will soon be followed by fully compliant, fully tokenized profit-sharing digital securities, made available to non-accredited as well as accredited investors. The sooner the better: the proliferation of compliant tokens that can be bought by ordinary people will be key to mainstream participation and blockchain adoption.
Ultimately, tokens will thrive by adapting to, and helping to improve, the regulatory landscapes of the countries where they trade. It’s no secret that bureaucracies can move painfully slowly, and that they are sometimes are loath to challenge their own long-held assumptions. But I am confident that well-designed tokens, with the right legal understanding and regulatory know-how, are the right way to move tokenized securities from the insurgent margins into the financial mainstream. And that will be a win for everyone.
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The Defiant is a daily newsletter focusing on decentralized finance, a new financial system that’s being built on top of open blockchains. The space is evolving at breakneck speed and revolutionizing tech and money.
About the founder: I’m Camila Russo, a financial journalist writing a book on Ethereum with Harper Collins. (Pre-order The Infinite Machine here). I was previously at Bloomberg News in New York, Madrid and Buenos Aires covering markets. I’ve extensively covered crypto and finance, and now I’m diving into DeFi, the intersection of the two.