Intro

Patrick: [00:00:54] My guest this week is Preston Byrne. Preston is a vocal critic of the crazy prices and projects in the world of cryptocurrencies. His background is in the legal world and also as a founder and former CEO of Monax, which made the first open source permissioned blockchain client. As Preston says, he is a blockchain without Bitcoin guy who believes that this crypto mania will end in some sort of apocalypse for token holders and Ico issuers.

We tackle several issues from his broad skepticism of crypto assets to the potential regulatory reaction from major governments to types of coins like Stablecoins, which Preston views as analogous to perpetual motion machines.

Nakamoto Schemes

Let's talk in some detail about your notion of a Nakamoto Scheme. So I think you had called some aspect of something a Ponzi scheme and then gone back and refined that idea a little bit. So maybe refresh on Ponzi schemes or pyramid schemes that are a little bit different. And then what you now call a Nakamoto Scheme, and what's distinct about it?

Preston: [00:02:29] So Ponzi schemes and pyramid schemes are what a lot of people who have first, particularly old men, in my experience, they look at Bitcoin, they go, "Well, this is a Ponzi scheme." And they look at it as a Ponzi scheme. Because you know, particularly lawyers, a lot of old lawyers I've spoken to, they look at it and they say, "Well, there's no rights or obligations, there's no one to deliver." They see the shell, and they just see people putting money in and somehow getting money out. So they say it's a Ponzi.

What a Ponzi scheme is, is when you have one person who sits on cash flows. So money comes in, money goes out, and they use the money that's coming in to pay the returns to earlier investors in the scheme and presumably to enrich themselves at the same time. So basically, it's one operator, centrally managing a scheme where they're fraudulent, they're saying, Well, the accounts are fraudulent and schemes fraud, and... Bernie Madoff, prime example.

So basically, eventually, if you have a rush on withdrawals, of course the cash flows don't meet the outflows. And so what happens to the scheme collapses under its own weight. Alan Stanford, another prime example. So with a pyramid scheme, slightly different, that's a little more decentralized, in that you have a person at the top of the pyramid, who then recruits two or three or four more, and then they recruit two or three or four more, and they pay commissions to people up the ladder, until eventually you go down to sufficient number of levels.

And the person at the top, if they've managed to recruit, another 16 people gets a big payout. And then the 16 say, "Well, he got rich, so I'm going to go do the same. Go recruit more," of course, that also runs out because, it's like the old Persian king with grains of rice on a chessboard. If you keep doubling and doubling and doubling, you run out of space really, really quickly, especially after 64 of them, for example. You wind up having more people than there are atoms in the observable universe.

So that doesn't really work either. So you run out of victims and scheme collapses under its own weight. Nakamoto Scheme, the term Nakamoto Scheme, is really a way of thinking about Bitcoin as a sort of updated Ponzi pyramid scheme, but one for the digital age. So Bitcoin operates very much like a pyramid scheme or a Ponzi scheme legally. There is no underlying subject matter, which makes it valuable, it is simply valuable because other people want to buy into it. And people buy out with new investor funds that have entered this game.

So that is very classically a kind of Ponzi-ish arrangement, but where it differs is that it's headless. So what you what the scheme does, instead of having identifiable cash flows to identifiable people, is it puts the cryptocurrency exchange between the buyer and the seller. It then extracts the demand, enter the scheme and the demand leave it as aggregate demand and aggregate supply.

There's no fundamental underlying thing that law recognizes as a legitimate subject of a sale. And then what happens is they just carry on and the thing runs itself. So the Nakamoto Scheme is basically just saying, "Look, it's not a Ponzi scheme, it's not a pyramid scheme, someone figured out a way to automate those kinds of interactions for a peer to peer cash system. But when you introduce speculation into that equation, it starts operating it a heck of a lot like your classical Ponzi scheme."

The Crypto Bear Case

Patrick: [00:05:29] I remember when I first started exploring this stuff, reading a post you had written called The Original Bear Case for Crypto. And at the time, kind of approaching this as a novice myself just being amazed that the market cap of all the coins was something like 150 billion, when I first started looking at it, and I think in your piece it was 170 billion, something in that range. And now it's 790, it changes by the day.

But it would be really fun having read the three part piece to go through that Bear Case for crypto as you laid it out, starting with that first one and I think you've got a couple different levels of apocalypse down to light regulation or something like this. So maybe we could start with the most extreme, which is, I think you called it the Marmot Apocalypse.

Preston: [00:06:11] It was The Zombie Marmot Apocalypse. So by way of background for your listeners, I wrote a series of blog posts called the Bear Case for Crypto in several parts. And basically in broad strokes, the first bit is that there's a huge regulatory risk. The second bit is that there is a liquidity risk. And the third bit is basically that grandma is going to come up eventually and start suing people and when you piss off grandma, that's never good for anybody.

But in the first bit, the regulatory part, there are three different subcategories of... It's like asking what stage of cancer you have, if that makes sense. So if you're very early stage cancer, it's very light chemo, that kind of stuff. And so if we're early stage in terms of this bubble taking off and getting quite entrenched in society, then it's likely that the regulators are going to take some time to get up to speed with it. They're going to need more time, and considerably more time a year or two before you start seeing major enforcement actions. And a lot of the projects that we're seeing today are going to pass by unnoticed.

I think that's where we were in 2014. So there were great many projects that were started in 2014. Some are active, some are not. But generally speaking, I think the only real major enforcement that we've seen from that era was a scheme called Paycoin, which actually took place here in Connecticut, and a guy named Josh Garza, he was selling mining contracts, that turned out to be something more akin to Ponzi schemes.

He then had a cryptocurrency, which said that it had a price floor which promptly broke. So price-pegged cryptocurrencies are not good for anyone who's ever read my blog. And so that was that kind of phase. The second phase is when you start to see more aggressive enforcement, but not full on. And that's where I think we are now. So we've seen China cracking down in various different ways, we've seen South Korea now doing some tax investigations. The SEC has been not quite as quick off the line, but I think they're probably doing their diligence. I don't think they're asleep at the wheel by any means.

The DOJ has said nothing, which is quite interesting. And you haven't really seen too much by the state securities regulators or state attorneys general yet. And I suspect that's because those are primarily driven by complaints, which we haven't had. Because if as long as everyone's getting rich, nobody's complaining a whole lot. So that's kind of phase two.

Phase three is The Zombie Marmot Apocalypse. And that is the sort of nightmare scenario where you see enforcement actions, exchanges getting shut down because of money laundering offenses. Sort of imagine what happened to BTCE, a couple months ago, but then happening to exchanges that operate here in the United States or exchangers that operate in the United States. It's certainly conceivable I think that you could or the United Kingdom, or any other western country, whereas BTCE it was Russian. I think the guys back home have been probably in the dialogue with the authorities and therefore, given something of a free pass.

Query how long that can continue, particularly as Congress and other entities start to acquire some cognizance of how this all works. And the numbers that are being presented to regulators start to look like things like long term capital management, or Enron or indeed Bernie Madoff. So we're now in the territory with a notional fingers that are involved exceed those three scandals by some margin. And so the question is whether this is going to be allowed to continue, or whether this is going to spook the regulator's into making very aggressive action and demanding reform by market participants.

So that's the regulatory angle. And a lot of entrepreneurs don't care. Usually, when you go, you could wind up in an orange jumpsuit for this. They're like whatever yellow, it could be Mark Zuckerberg as well. So why don't we do that? But, my background is as an English structured finance lawyers, so I clearly look when the only tool you have is a hammer, the whole world looks like a nail. So my training is to go and identify those risks and so that's just how I look at it.

Patrick: [00:09:58] Can you get into this sausage factory a little bit with this issue in particular, where you've got a whole bunch of interested parties here, one of which is a very powerful kind of venture capital backed technologists back. Some of the smartest people that I've ever met are hugely behind this movement. But the extent to which they have sway over the regulatory path, who the various parties are, that are influencing this, and how that actually happens. Like I talked to Peter Van Valkenburg is an example, as part of the Hash Power series. He is a really thoughtful guy, and obviously he is trying to help thoughtful regulation happen.

But from the perspective of someone that supports cryptocurrencies and blockchain, so can you talk a little bit about like who the major players are that might influence when and to what degree there will be new regulation in the US specifically?

Preston: [00:10:45] So in terms of who is influencing when new regulation will come about, and this isn't necessarily US specific, it's going to be when a prosecutor needs to make their career on something, or when some politicians get spooked because they start getting angry letters from their constituents, which I don't really think has happened anywhere. And then on the flip side of that, of course, who are the formal lobbyists in cryptocurrency, you have Perianne Boring's group down in DC and you have Coin Center with Peter and Neeraj and Co.

But really apart from that there isn't a formal lobbying effort. So what it is, is you have the regulator's looking in from outside and seeing all of the glorious claims that have been made, you know the cryptocurrency can do this, and it's wonderful, it's going to bank the unbanked and do this and do that. They don't necessarily have the technical chops on the regulator's side, or frankly on the venture capitalist side, either to really sense test those claims.

I remember about two years ago, when people were starting looking at enterprise blockchain, there were VCs, who were saying, "Well, this could never possibly work, you need the mining in order for the Bitcoin to happen." And you're like, "Well, no, you don't, that's just a consensus mechanism, you can swap it out and do something else." So they wrap their heads around that eventually.

So I think there's a degree of misunderstanding as to how the technology actually works, what its limitations are, what it can do, that tends to be quite serious on the regulator side, somewhat serious on the VC side. But then again, the VCs have the interest in making sure that startups they're funding, attract public interest, and that people buy and use their services and that sort of thing.

So I don't think generally across the industry, we're having a serious enough conversation about how serious the limitations are on the technology. And in particular, people are very reluctant to stand up and challenge claims that are made by people who support the technology. So if someone says, Bitcoin will make the world more equal and make things financially great for everybody. And you look at it and go, "Well, actually, the Gini coefficient of the Bitcoin universe is 0.89," which is about 2% worse than North Korea.

Patrick: [00:12:41] So Gini coefficient meaning wealth concentration.

Preston: [00:12:44] Correct. The wealth in Bitcoin is concentrated in very few hands. In fact, more so than you know if it were a standalone economy than any other economy on Earth. So it's really hard. And then people will say things like, "Well, Bitcoin will disrupt governments and render them obsolete." So there are all of these forward looking statements that we see being made about this currency, which is basically, operates in society as an investment, but which no one really has standing to challenge. And if they do, they get shouted down by legions of people on the internet who say, "No, no, no. You're wrong about everything." So we have this very compelling sales pitch with not a lot pushing back against it.

Patrick: [00:13:22] Maybe we can get into a little bit on the notion of a digital asset. And I think you've written in a few spots about utility of blockchains, being intrinsic to the blockchain itself, versus a token or a coin being some claim on some external thing. So maybe you could outline that important difference. And from a legal perspective, why that's important.

Preston: [00:13:44] Blockchains kind of ape real world assets and real world things. They feel like them, but they're not legally the same as what you would understand to be a stock or a bond or a share. So if I have a stock or share in a company somewhere or a debt instrument, a bond some other type of note, the reason that has any value at the end of the day, is because I can take that thing to a court and I can ask the court to enforce it.

So legally, we call these things shows as an action or things in action. They only have existence when you go and file an action with a court and then go and seek its enforcement. And then you can send men with guns around to the debtor or to whoever else owes you that obligation. And you can enforce that obligation against them in the form of a judgment debt or order for specific performance or something else.

So that's what these things are. They're really just evidence of an agreement, which we trade and we trade freely and whatever, but at the end of the day sitting behind it, there's always the threat of enforcement, which is going to happen through the legal system, which is going to happen with the police or with bailiffs or the sheriff or whoever else you need to get on your side to go and go and enforce it.

With the crypto assets, it's a slightly different situation, in that you don't have ownership as such because everyone has kind of disclaimed ownership. So with Bitcoin, Satoshi has not turned around and asserted intellectual property over the database. Similarly, none of the users of the system would have standing or if they did have standing, they certainly haven't asserted a database or something similar over the Bitcoin database.

So it's one of these weird things where everyone has said, "You know what? We're not going to touch it, we don't want to own it, we don't really want to opt in to any part of the legal system. Because if we do that expressly, then the legal system knows how to deal with this thing that we're running around and trading and chiefly, if you basically said it was a right to anything, it would become a security, and if it becomes a security and then obviously, within that regulatory regime."

So with Bitcoin, the asset is intrinsic, it has value because people think it has value. It's basically just a right permission UTXO that you have on this database, and people will buy it from you because they think it has money. But legally, there's nothing underpinning it. And so as a consequence if people stopped buying, it disappears, it has very little meaning. So it's dependent. It's basically a giant meme with no legal substance as such.

Patrick: [00:15:58] What do you think about Adam Ludwin's idea of really the only value in these things being this idea of censorship resistance, that censorship and judgment resistance, that maybe what you just described is the only feature. So the fact that I'm willing to own Bitcoin and ascribe to it value. And let's say I'm a true believer that thinks that in 10 years, I'm going to be able to access my Bitcoin and somehow use it as to do something productive or preserve value through time, or one of the things that people want here that no governments can have any say over, and that I'm basically relying on global hash power to be the security underneath it versus some judgment system.

Preston: [00:16:36] Yeah, I think that's a little overrated, because at the end of the day, there's the old XKCD cartoon, which is, "Haha zones, I've got this RSA three million bit password, you'll never be able to break this." And they're like, "Well, why don't we just go around his house with a rubber hose and a $5 wrench and just beat him up and then we'll get what we want."

Governments have been around for a really long time, and they know how to get stuff done. And sometimes that stuff can be incredibly unpleasant. I agree with Adam in that Bitcoin is a very censorship resistant system, more so than any other distributed system or network system I can think of. But is that why people use it fundamentally at the end of the day? I don't think so. I think it's more basic than that. People use these things primarily for gambling and speculation. I think that's the main use case is that it's an unregulated penny stock casino of the 21st century. And whether we want to admit it or not, that's always been a compelling proposition.

People have always wanted to go into casino, the promise of instant riches as we've seen, with ripple of late. So there are people who got in at two cents and it's of course worth $2. And so they're running around saying, "Hey look, my Lambo, isn't it wonderful." And that's really compelling to people who are weak minded, and even people who are quite strong minded when they say, "Well, hold on a second, what am I missing out on?"

So I think that's the primary value prop of cryptocurrencies. That's what people are using them for, they're not using them for censorship resistance. And the guys who would use them for censorship resistance like Amir Taaki or Cody Wilson, or any of these sort of original crypto anarchists, those guys are all using other stuff now. They're all using Monero and other cryptocurrencies that haven't been speculated on so wildly and so as a consequence, they work.

So maybe from a money perspective, what we're looking at is not one cryptocurrency dominating because cryptocurrencies are kind of their own worst enemies. When they become too successful, they become unusable. So maybe it's the ecosystem itself, which is worth something and so one cryptocurrency will rise and another will fall at the same time and gradually as Bitcoin or Ethereum becomes too unwieldy, something else will rise up to take its place.

Patrick: [00:18:38] Can you say more about why that idea is true that as they become more successful, they become unusable? Why is that a necessity? Why couldn't some new cryptocurrency let's say it's Monero, violate that idea.

Preston: [00:18:48] Blockchains don't scale. And the bigger they get, the more unwieldy they get. So there was a claim that was made, let's use just Ethereum as an example. Zero Hedge that fine pillar of American journalism, the old grey lady. So Zero Hedge had an article on it sometime over the summer, when the enterprise Ethereum Alliance, that august group of startups and financial institutions united for a better world, decided in their infinite wisdom, or someone in it, I suspect, in their infinite wisdom decided to tell Zero Hedge that Ethereum was planning to scale to a million transactions per second, sending the price to $2,000 per coin.

And so I don't know who did it. I don't know why anyone would say that. So one of those predictions has actually turned out to be somewhat true. I think it's at $1,500 a coin now. The other one that it's ever going to run a million transactions per second is twaddle, it will never happen. And the reason for that is quite fundamental. It's that you're constrained by the speed of light. That is your enemy when you're running a global distributed system. It takes something like 14 milliseconds for the speed of light to go halfway around the world. And that's in a straight line which never happens because it gets routed through all sorts of other things.

Every transaction that gets propagated on that network gets propagated to a bunch of other computers, who then have to verify it, and then re propagate it. So everything about one of these distributed networks, in this instance Ethereum, is slow. The hardware that is running it, is slow. The fact that it's widely distributed means it's going to be slow, no transactions are going to head in a straight line. The fact that you have to go great distances means it's going to be slow. And all of that is going to operate to slow down what the system can do, and prevent it from scaling efficiently.

So people are making these wild claims about these systems. But the fact is, every time we see one of them being used on a global basis, it becomes more unwieldy, the larger it gets. As the price goes up, the fees go up because the fees are priced per byte. And so if it's Satoshis per byte, so if a Satoshi becomes more expensive, assuming that the transactions are the same size, you're not going to get cheaper transactions, they're going to be more expensive.

Patrick: [00:20:53] Proponents would place a lot of hope or desire for the future in off chain scaling. So things like Lightning network or layer two or side channels or whatever, why do you think we might not figure out some way of innovating a solution to this problem so that the on chain scaling doesn't ever have to happen that we can use it as like a settlement layer, use Bitcoin as a settlement layer, and basically have all the smaller higher volume transactions happen in a less secure way. But in a way that's still tied to the underlying blockchain.

Preston: [00:21:22] I would rather use Coinbase, to be honest with you than use Lightning, because at least with Coinbase, I know where this stuff is, I can track the transaction, I have a record, I can do things like screenshots. And at the end of the day, if they screw up, I can sue them and get some money back potentially.

So I think that if that's the approach we're taking, it doesn't make a whole lot of sense to say, well, payment channels are gonna fix everything. Because in order for that to work, every user of the network has to be opening and closing several payment channels per day, which is it need to be leaving their computers on, which not everybody does. So a lot of these solutions assume a lot about how dedicated and committed your average user is going to be to the Bitcoin network. And most of them frankly, they probably log in once, buy some Bitcoin, turn the thing off. And I have some friends in law school now who are basically going "Well no. I bought some, here's my Coinbase account. And what should I buy next?" And I'm like, "No, I'm not doing that, we're not playing this game."

But yeah, basically, I think you might as well just go with a centralized solution at that point, because it's going to be faster and more efficient and it's here now. And then you just assume that your settlement layer is going to be Bitcoin and you have Coinbase as your bank, and you just have a deposit at Coinbase, which you can withdraw at will. And then if the fees are reasonable, you can go send it somewhere else.

Patrick: [00:22:29] When you study most manias you brought up in one of your posts, the Railway Mania, and when you study most mania is typically there's something very exciting at the core of it that kicks it off. And often times, once the bubble has inflated and popped, it still become a key part of the kind of technology establishment of the future. But there's all sorts of misallocation of capital that happens in that middle period. So maybe talk about that maybe even using the analogy to railway's. With the vision on assuming this is a bubble, we'll take that for granted right now. And it pops and it goes down 95% or whatever the percentage is, what comes next. What's still exciting about it to you?

Preston: [00:23:06] What's exciting to me is I always thought when I started my company back in 2014. We started that with the view that we wanted to take back control of data from the big data service providers. So we were building a prototype on Ethereum or rather an Ethereum test net. What we did is we decided we're going to automate organizational governance for a 501C6 nonprofit organization on a blockchain.

So we wrote a paper, your typical crypto white paper, except ours was actually good. I wasn't trying to sell anything. We then described the functionality, there was shareholder governance, that sort of thing. And we said, "Look, this is a way that if you want, you can take a bunch of people and a bunch of different places, and you coordinate your actions like you would a Google Doc, like you would on Amazon S3 or whatever else. And you can do it without actually using the third party service provider.

So you can have this infrastructure, which is yours, which you control, which no one can see or well, which no one's going to have access to other than you. If you need to, you can run a VPN and do it over that. But this is a way that you can all talk to each other and keep in sync without needing some big stack very far away, running all of that infrastructure for you. So you're going to move all that onto your own platform and run it that way."

And that's because we saw then and I think it's just as true now we saw with centralization has risks, those risks are political in nature. We saw today that Twitter is actively censoring conservative political opinions, the much maligned conservative political opinions in the United States today, greatly victimized group of people, no doubt. In case you can't tell them, I'm a little biased.

But I think there's a major risk in putting too much power into the hands of tech companies full stop. And I think blockchains allow us with Bitcoin. It's peer to peer money, but what's it really allowing you to do? It's allowing you to run an accounting system without a bank. It's allowing you to run an accounting system without a credit card company. It's taking out the middleman and you can reskin it and tell it to manage whatever set of legal rights you want, as long as you have some trustees somewhere in whom those rights are vested. And when you do that, then you can have it operate totally normal, totally in harmony with the legal system.

But what you've done, is you've taken someone else's servers out of the equation, and you're running the thing yourself. So I think at the end of the day, that's where we're going to wind up where you'll have companies doing their internal treasury services on a distributed ledger instead of doing it through their bank. That's one thing you could potentially do. So one of one very many. At the end of the day, you don't really need the coins to achieve any of that distributed infrastructure that doesn't rely on third party cloud services. You can use hyper ledger for that.

The Investor's Perspective on Crypto

Patrick: [00:25:40] So I always think about things from the perspective of an investor and the meme that's caught on in addition to Bitcoin, is this fat protocol idea that the value associated with these networks, that they have some use case, they do something for people, and that the value accrues to the token holder. Right? So the token is the unit of exchange and little mini economy. Certainly, there have been some companies coin base, the best example, traditional companies that are enormously valuable, that looks like any other financial intermediary, charging a point or whatever it is on either side of the transaction.

In that world, what is the incentive to build that technology? It sounds like you're saying we don't need tokens or coins where valuable accrue. But the incentives are always such that people build stuff, because they are incentive to do it financially. That's where people are entrepreneurs. So how do you think about, like the motivations and the installation of that technology in the absence of a return to investors in coins?

Preston: [00:26:34] I think that the... Have you seen the movie Aliens?

Patrick: [00:26:36] Of course.

Preston: [00:26:37] You know when they're all sitting in the dropship. And Bill Paxton is totally freaking out. And then Sigourney Weaver is sitting there and she goes, "You know, I say we take off and nuke the entire site from orbit." When the SEC published its Dow report over the summer, they effectively nuked the fat protocol thesis from orbit. That is what they did. And the language that we're using to describe it, says it all. It's that in form and substance, we have companies that are saying, "Hey, we've got this piece of the protocol which you can own as an investment."

And so if it's an investment here in the United States, the question is, have you got a prospectus? So does an exemption apply? In Britain, same thing. Have you got a prospectus or do you have an exemption? Well if you don't, or if it's money or money's worth that you're trading with other people, have you KYC them? Have you done AML?

I don't think that the rules are going to go away anytime soon. And they shouldn't go away. They're there for very good reasons. So I don't think that makes a whole lot of sense. In the current environment, obviously, people can raise a lot of money really quickly, and then deploy that very quickly to go and build out these networks. And that pushes all the right buttons for people who support that thesis. It says, "Hey, people are interested in this." But whether it's sustainable or not depends on whether we can get the regulators okay with it. I don't think that your average Silicon Valley VC has really had a whole lot of interaction with financial services regulators over the course of their career. A wall street banker or lawyer however, will have had that degree of interaction.

And I was talking just the other day to a very senior structured finance partner at a very eminent global law firm. And they all had a whip round and discussed it. And they agreed, they said, "We have no idea why these guys don't have the same concerns we do considering for all of our deals, this idea of selling an investment or something that feels like one. And the compliance which goes along with it is so central to it that we make sure we're not only on the right side of the line, we're a mile away on the right side of the line."

So in the current environment, it looks like "Yeah, go do the token, bootstrap the protocol, get lots of interests, get a trading on an exchange." All of that sends all the right key indicators to VC, you have 10s of thousands of new users a week. It's getting press, people write about it. They're excited, shill's on Twitter, running around and harassing people who say, "well, maybe we should calm this down a little bit." The XRP shills are just insufferable. I'm just going to put that out there, which is interesting.

But right. So it pushes everyone's buttons because they see the virality of it. But I don't think they see the legal technical debt that they're building up by following that approach. And so it makes perfect sense to continue on that angle, as long as there are no consequences for doing so. If the day should come when there are consequences for doing so, then we're going to see the real cost of following that route. And then the question is, does it make sense without a token?

Patrick: [00:29:21] Maybe describe Ripple for a minute. It's something we haven't spent a ton of time exploring on this podcast, in large part because it really hadn't done anything and then since the last one, it's exploded in value. So maybe give you a perspective on what it is, what it promises, and why that may be is going to be hard to fulfill.

Preston: [00:29:38] Well, so I mean, Ripple Labs is a company founded by Chris Larson, and then they've got David Schwartz and Stefan Thomas who've been around forever. And they've done a bunch of different things over the years. Obviously, I've never worked with or for them, but they did, so what did they do? The first project was XRP, which was basically if you talk to Peter Todd, he'll tell you, "It's centralized." If you talk to ripple, they'll tell you "It's not centralized." I'm not going to go into that in any depth here.

But there's a cryptocurrency, it's proof of stake. Ripple, more or less determines the consensus of the network as far as I understand it, and that's that. And then they had two other projects. One of them the name escapes me, it was a sort of smart contract oracle type project. And the other was called Interledger, which is a very similar project to your hyper ledger style, distributed ledger. And so my understanding of what they do is primarily they're doing distributed ledger implementations of inter ledger at banks, which is derived from the ripple consensus ledger rather than XRP.

Of late Of course, we've seen XRP's price go through the roof. So I can imagine they will have had changed their stance on that somewhat, because it seemed a couple years ago that they were almost like, "Oh, no, no. That's kind of our redheaded cousin that we don't pay too much attention to and we're just going to put them over here in the closet and not pay much attention to XRP. Because, it's blockchain without Bitcoin now," and this was like 2015.

But now of course things have changed. So ripple is just a company that has a cryptocurrency. They also have a really interesting distributed ledger proposition. Again, my understanding was that they were going into things like treasury services. And so they're trying to keep a toe in one ocean and a toe in the other sort of enterprise and cryptocurrency. And that's a story we see more than once. I know of other startups, which have basically said, "Look, we're not ruling out the coin thing, because there's so much interest in it."

Patrick: [00:31:19] I'm always fascinated by the early stages of, I guess we're not in the early stages anymore. But this insane on ramping of users on the Coinbase or whatever, and real fiat money now coming into the cryptocurrency sphere, where there's, I think market cap is a really flawed metric for thinking about this, because you could say that bitcoins got whatever 200 and whatever it is today. Hundreds of billions of dollars of market cap, but if any meaningful chunk of that tried to actually liquidate into fiat, it would be a fraction of that.

And that's largely because when you add up the total amount of fiat that's gone into the ecosystem relative to its notional market cap, I think it's tiny. Right now it's growing very quickly, but I think one of your key points is, whenever that reverse is, it could be a really scary proposition. A run in the bank, grandma getting pissed off or whatever. So talk about and maybe the answer is regulation, heavy handed regulation coming down the pike. But talk about what you think might precipitate that kind of reversal in the relatively near term future.

Preston: [00:32:19] Sure. So I called that a run on the bank and I caught a lot of flack for it, including from Matt Levine who was like, "Yeah, okay, great. It's like people are selling, prices are going down. I don't understand what the point is. This happens in securities all the time." But I think the difference between your crypto sphere and something like shares on Apple or Amazon, the psychology of the buyer is very, very different when they're purchasing some cryptocurrency. And they're purchasing stock in a company which is going to go in their 401k or something like that.

The difference is that with cryptocurrency, they think it's money. On the cryptocurrency you show $1 balance, and similarly with a brokerage account, you can also see $1 balance how much all the securities in it are worth. But I think that here, people are really looking at it more like cash in the bank, which they were expecting to simply just go up in value. In some cases, there are anecdotal reports, which I expect are true. I had no reason to disbelieve them, that people are doing things like spending money on credit cards for example, to go and get 20% interest to go and get exposure to the market.

So with that as our background, the thing that will freak people out is the thing that freaked people out, we haven't had one of these in a very long time, it's a run on your bank. So if someone goes to Coinbase or somewhere else, and there isn't someone on the other end of that trade, or there isn't enough liquidity to go and satisfy withdrawal demand, then what will happen is withdrawals will be cut off and people will panic. And they will say "Hold on a second, oh my God, I can't get my money out," and they'll try to move to whatever dwindling pools of liquidity are left.

What could precipitate that? Potentially, an exchange getting taken down by regulator is one thing which could do it. And there are some, I don't want to name names, but there are some suspicions about whether certain cryptocurrencies are being legitimately issued or some tokens which are meant to be backed by money. People are wondering where's an audit, potentially that proves that those tokens are actually backed by the money that the issuer claims it is backed by. So in the case of Tether, just for example, they claim it's backed by $1.2 billion of fiat sitting somewhere in a bank account. But there's been no disclosure basically saying that we in fact have $1.2 billion of cash sitting idly in the bank account somewhere, which would be rather a lot of money sitting idly in the bank account.

So any one of those things could trigger a loss in confidence and we don't know when it could happen or how or from what, but those are just some proposals. And then, this is a meme on the way up, it's going to be a meme on the way down a change of expectations and reverse network effect or inverse network effect, which pushes prices down. This can't go up forever. It's a mathematical certainty that that can't happen.

Reverse Network Effects

Patrick: [00:34:51] I saw you writing about this just today or tweeting about it. There's something about this reverse network effects, which is a really interesting idea. It's such a popular buzz phrase especially in Silicon Valley, because positive network effects can be so incredibly valuable, can create such a moat around a product or business or service. So maybe talk about that idea of reverse network effects relative to these positive ones.

Preston: [00:35:14] Blockchain is a journey. I'm saying this sarcastically for your listeners, but it is a journey. It's a process where you first get exposed to something like Bitcoin, you have no understanding of it whatsoever, you then dive in because it's profoundly, it's an attractive idea. And then when you pair it up with trading and all those other things, it's very, very attractive. And for me, when I looked at it, I dove in headfirst, because I'm generally quite pessimistic about everything, but wound up becoming quite pessimistic about it, and started deconstructing it.

Tim Swanson was another guy who thinks along very similar lines. And so we became the early Bitcoin skeptics back in the day, and so that continued being so ever since. I think similarly for everyone else who's getting into the market now, they may be enthusiastic now. But the question is what will turn their enthusiasm. While I can't spend the damn thing, it's not accepted anywhere, the value has gone down, it's cut in half, I couldn't get my funds out in a week. So there are going to be a lot of really disappointed people, just as we have been disappointed before them in the infrastructure that the cryptocurrency world is built.

And so that could be something which repeated hundreds of thousands of times then creates something where people say, "Well hold on a second, maybe Monero is actually better." I like Monero because I'd like Ricardo, the guy who founded it. He sent me a rock hyrax which is kind of a Marmot like creature, but a cuddly toy of a rock hyrax in the mail once. When a cryptographer asks you for your mailing address, like never say yes, right? Because it's like what are they going to do, steal my identity? I don't know.

It's like "What's your address mate," I was like, "Okay, here's my address." He sends me this cuddly toy. And so basically Monero is the best ever since, or like Zcash or something like that, or someone comes up with something which is more scalable. I know one project in San Francisco, I don't think I can name what it is, because I don't want to blow their cover, which is looking at more of a distributed way of running a blockchain. I know that IPFS and Filecoin for example, there has been talk in the past of potentially mounting a blockchain onto the IPFS data store.

So if you could do that, then you have one of the potential solutions to scaling, if that makes sense. I'm not technically astute enough to tell you whether that is or isn't the case. But those are some potential solutions. If someone does that and Bitcoin doesn't or Ethereum doesn't, you could see a migration over to that because suddenly you have something which is usable, instead of downloading a 200 gigabyte client onto your computer, which takes four weeks to sync. So that's how those things happen and I don't think people are quite aware enough that the software they're using is not well written and not very user friendly.

Thoughts on Stablecoins

Patrick: [00:37:45] Talk about stablecoins a little bit. This is something that you've written a lot about recently, it's a popular topic-

Preston: [00:37:50] I hate them.

Patrick: [00:37:52] We know you hate them, we'll get into why. I think that the core underlying attraction of a stablecoin or something that just has stable value like a US dollar might, is that you know you can conduct commerce with it, you can pay for stuff, you can use it as a means of exchange, if there was a cryptocurrency, which had all the technological benefits and the digital benefits that a digital currency might have, but you could rely upon it to have some similar purchasing power this week, as it has next week. That could be a really neat technology.

So first, do you agree that that is something useful that we should, let's assume that a stablecoin was possible, which I know you don't think it is, but is that something that's desirable? First, I don't want to presume you think that and then we'll get into why there are significant problems with this idea in your opinion.

Preston: [00:38:37] It's something that's possible for sure. We have electronic money today, which is redeemable against some deposit somewhere. And so it's electronic money when you hold the thing, but there is a deposit somewhere which corresponds to what you were spending. The idea of the stablecoin is that you can take it's not, again getting back to this intrinsic idea. It's that you can take a cryptocurrency on which people are speculating, which has value because people are speculating on it. And then you can set up incentive arrangements around that speculation on the cryptocurrency, together with a price feed which is determined by some computer external to the system, which allows you to peg the price of a certain amount of collateral in that cryptocurrency to whatever that third party thing is. So it could be $1, it could be an ounce of gold, it could be something else.

So basically what you do is you set up a derivative contract of sorts where someone has a long position and a short position. And as the price of the underlying collateral pool moves up or down, someone either wins or loses on that trade. And then if it goes too far out of whack on the downside, it closes it out. And then you go and pay someone whatever amount of cryptocurrency they're entitled to.

The problem with this is, is that it's basically a perpetual motion machine, because you can't... People say well, pressure, well that's a criticism people make about technology. Well, no, it is a criticism. When you say something's impossible, you run the risk of someone who has seen a lot of technological development, or someone who thinks they've seen a lot of technological development and know what's going on saying, "Well, no, you're just being a Luddite and you don't understand how things work and you don't understand the technology advances."

In this instance, it's not really a question of the tech, it's just a question of human behavior. And that is that the only way you can maintain those pegs, is if people continue to buy the underlying asset which you're selling, which supports that price. If people stop doing that, then the peg breaks and the collateral will eventually erode itself. And that can happen for any number of reasons, it can happen because people have a loss of confidence, it can be happened because the team winds up and goes away somewhere else and goes to Tahiti with their ICO money, for any number of reasons.

So basically, the schemes are not sustainable, except under an environment of ever increasing prices, which is mathematically impossible. This hasn't stopped a bunch of bright young things from Stanford and Princeton from attempting this. But I think the stablecoin is kind of how to put it, it's late stage crypto. It's a bunch of guys who've been trained to think you can unit test everything, thinking you can also unit test human behavior, and predict with certainty all of the outcomes. The problem with that of course, is that once you know that you're being unit tested, and you know the rules of the game, you can go game it because we're self aware. And that's what stablecoins basically, that's their inevitable fate.

So we saw this with BitShares a few years ago, there was a stable coin that created it. Within 100 hours, it fell flat on its face, because no one had confidence in it and so they started pulling their money out. And so they had to turn the system off. Similarly today with DAI and MakerDAO, which is another stable coin scheme, there was a loss of confidence in that scheme, because of some events we don't know what caused it. But I'm presuming it's an event extrinsic or external to that system. So they said, "Well, we built this wonderful little closed system that in theory, it works really well." But one trader was like, "You know what? I don't want to play anymore. I need this money now. And I'm not going to play along with this whole dollar price thing, I'll sell it for 70 cents, I'll sell it for 60 cents."

Really it doesn't matter, pulled all their money out. And so the peg didn't hold. So it's this idea that you've got these bright young guys saying, "Well, hey look, we can build the system, this computerized automatic money system, which works without really understanding that the reason something has value is because people are looking at it not because the algorithm says it should."

Patrick: [00:42:12] Setting aside price and the market cap of these things and kind of the madness that's happened in the last couple of years, sitting today and looking back to 2014, which is sounds like when you got really involved starting a company. What would you tell yourself now that you know about blockchains that's most interesting, from the perspective of you back in 2014. So what have you learned most outside of just the investment side and the speculative aspect of all this?

Preston: [00:42:38] I mean, the investment side is actually the thing I've learned most about. And that's chiefly that gambling is very, very easy to sell. So if I had to go back to 2014, I wouldn't have ICO, but I might have taken some different positions than I then I ultimately took. In terms of the tech, the adoption curve has been very slow. So it's getting something to production in this world is very, very hard. There are very few companies which are ready to do it. Generally those companies are large banks, and then the sales cycle for those banks is agonizing. I mean, it takes a year just to get approval for a follow on from an initial prototype.

So it's one of those things, which if I could go back and tell myself what I was getting myself into, maybe run a little leaner and a little quieter, and wait until there's more budget available to do this, because it's taking a lot of time, because the technology is so different from everything that everyone's already using. And it's not really coming from or at least until very recently, it wasn't coming from the main enterprise vendors. I don't think Oracle has a blockchain offering. I know Intel does now, IBM does, Microsoft does, Oracle does not, Amazon does not. So and they weren't going to really jump if you walked in as a small startup and said, "Hey, why don't we just go like a redo your whole back end? You know all these all this stuff you've been using for 20 years. And trust us, we incorporated last week, it'll be fine."

So I think if there were any lesson it would be that, it will take every bit of the 10 years. I think 2024, 25 it'll just be embedded, no one's going to notice that it's there. But it will take really every minute of those 10 years.

Patrick: [00:44:11] Say a little bit more about that. So 2025, describe specifically what you mean by embedded and or ubiquity or whatever.

Preston: [00:44:17] So there are a couple of things which need to be fixed from a usability perspective. One of them is key management, there are no really good solutions. There are a couple ledger labs is a fairly good key management solution, but it's focused primarily on cryptocurrency. Similarly, there are no really good outstanding user interfaces for daps. Ethereum is there, but it's not great. It's slow, it's clunky. So the infrastructure just isn't there yet. We haven't really seen people starting to use this stuff as part of the core of their businesses. It's still a curiosity and a toy.

That's not a bad thing. I think it was Chris Dixon. I could be wrong, who said, it's a toy today, but that means or maybe Chris Dixon or Fred Wilson one or the other. They say everything that there is to be said, right? So it's a toy today, but it's still a toy. We're still not seeing someone saying, "You know what? I'm going to go put real transactions for real money for real customers running on this system if they're a core bank or you're one of the globally significant financial institutions." So that's what we're not seeing yet, but we'll get there in due course.

Thoughts on ICOs

Patrick: [00:45:18] Let's talk a little bit about we haven't talked explicitly about ICOs, you wrote somewhere that when you hear tokenization, you should really just replace that in your mind with cutting corners. So talk about your perspective on ICOs which I think is almost universally negative, but why it's negative. And if there are any positive aspects to this, let's call this a use case of cryptocurrencies, which is raising a lot of money really quickly with very few barriers.

Preston: [00:45:41] So I think without being overly pessimistic, I can be overly pessimistic online and on Twitter, because there just aren't enough characters. And it's just more fun that way to get people riled up. Because I'm sitting there and someone's, getting bent out of shape, I'll send them a marmot picture of something to just annoy them. It's great fun. So I'll try to be more diplomatic here.

So with ICOs I said, "Yes, it's cutting corners." What they address is a huge demand for higher yield investments. People have been sitting around on very low, you can't get interest in a bank account in the United States, that doesn't happen. And people have an appetite for a little bit more risk, and so I think ICOs have addressed that appetite for risk. And that tells me that there's a market there, an addressable market, which could use blockchain technology as part of whatever solution you build, to give people access, to investments to give them disclosures relating to those investments, to have a more direct way of communicating with an investor about an investment that they own and potentially getting them more involved with that investment.

Because if you've got, let's say, you've got a smart contract which says, this is your share and whatever, you could go and consult that investor automatically about a shareholder meeting. You wouldn't have to actually go and summon them to the shareholder meeting, in order to go through the motions and that sort of thing. So that's one potential way of looking at it.

The reason I say it's cutting corners is because a lot of people are selling things which are designed like investments, which work like investments are treated like investments, but at the end of the day, aren't really investments. So I've seen a couple of real estate, coin this or real estate coin that where someone goes, "Well, it's a real estate investment thing, and I'm going to go buy this house, and I'll put it all together." So that way you get the return, or the Dow, another prime example. "This is a decentralized company, we're going to go invest in other companies, they're going to have their own tokens, and you're going to get the return." And people are like, "Great, this is amazing. Let's go invest in the Dow."

But if you looked at all the little moving parts between there, it's like, Okay, I take the tokens, I put them into the Dow, there's no contract, which says what happens, I just know that I get these Dow tokens back for the ether I put in, then the Dow takes the ether I put in and it gives it to another company, fine. That still works, that company issues tokens, okay, reward tokens, those reward tokens capitalized back into the value of the Dow tokens, it didn't say how there was no mechanism for some company that went and issued its own ERC 20s to then go and capitalize back into the Dow tokens. It was just kind of like, "Oh, no, no, and that will happen, magic happens because they've done it through the Dow structure."

And then I go take that value, which is capitalized in my Dow tokens and sell it to somebody else who wants it because decentralization, right? If you are a lawyer, you'd go, "Okay, well, you're paying money in here, and then you're paying money there. And then this company does that and there are certain rights which you're going to take in exchange for, let's say that company liquidates and there's a contract which says that when you liquidate, we turn around, we sell the assets, the proceeds of that sale go to this entity, those proceeds are then distributed in accordance with this waterfall." So it ties all of the little pieces together and makes a coherent whole. That's how a legal transaction works.

But Dow and a lot of the ICOs have seen they're cargo cult of the east pacific, where what I'm referring to are after the Americans came in, during the Second World War, some of the people who lived on the islands would go and build mock airways and planes that have bamboo. And thinking that if they did that, a cargo would arrive from the people in the sky. So basically it's, and Richard Feynman called that cargo cult science, it has the appearance and trappings of science. It makes perfect logical sense, but it's missing something. It doesn't get to the essence of what you're trying to achieve.

So similarly with the Dow and a lot of these ICOs I look at it and I go, "This is cargo cult law, you are kind of brushing over the surface of what you're trying to accomplish." But I mean, you're touching on it, it looks right, it feels right, you're selling it, there's a little contract, they get a token. That feels like owning a share, they can see what their balance is worth if they have it on Coinbase or whatever else. But if you then just dust off the surface and look underneath, none of the machinery that's necessary. And none of the work that needs to be done is actually there.

So you don't have a mechanism by which and that'll come out, we'll start to see more of it as people start to get annoyed with ICOs that are non-performant. They'll say, "Well, hold on a second, you sold me this thing and there's actually no means for me to connect one on the other."

Patrick: [00:49:56] No recourse.

Preston: [00:49:57] No recourse, no nothing and so I think the SEC went after one guy, there's an emergency order a short while ago who was doing real estate in diamonds. And I think they probably took, I haven't looked into it myself. But my guess is they probably took one look at what was going on and said, "This isn't join up. This doesn't make sense." And so there's a lot of that out there, starting with the Dow, which got away with it. And since then there have been a bunch more, and so we'll see more of that. But that's what I mean when I say it's cutting corners. You haven't done the necessary work in order to provide what you're purporting to sell.

Patrick: [00:50:27] What are the conditions under which these things will be legally viewed as securities? So I think it's the Howey Test. What does that mean? I've heard from a lot of proponents who are certainly pro cryptocurrency and blockchain technology, that they would love some opinion from the SEC, and they'd love more regulation because it would remove some degree of uncertainty and allow people to really start building. So what do you think about the security label itself and how it will come in when it might come for ICOs generally?

Preston: [00:50:56] So subject to the proviso that I'm not yet a US qualified lawyer, and I'm an English qualified lawyer, I will be very happy to and this is not legal advice, I will be happy to talk about my understanding of that concept. So just starting with the way things work in England, just by way of comparison. In England they've incorporated a lot of European law, which tends to be big, long codes, which set out everything unfold as fully as they can.

So they have a list of things and they say, "If it's not on this list, it's not subject to the prospectus directive and it's not part of this regime." And so I looked at the list in the UK, and the FCA made some comments that basically the UK is equivalent to the SEC. And they said, "Well, we don't think a lot of these tokens are going to fall within that list in that regime." And I think they're right, because when you look down that list in England, try as I might, I can't see anything on there which tells me that a blockchain database with a Genesis block that had some tokens, which are retained by the issuer, and then the remainder are sold to people on the public, there's a big exhaustive list, and that's not on it.

So it's not a security. It might be something else, there are all kinds of other representations that you make when you sell these things. So you could say, "It's going to go up in value to X and if it doesn't do that, then you're committing fraud," for example. So there's a whole bunch of stuff to consider, but that's how that works. There's a big list, cryptocurrency is not on it, not a security. The US has a slightly different regime, in that they have a common law test. So it's kind of mushier and it asks four factors and it says, "There's a scheme, is there an investment of money with an expectation of profit from the efforts of others in a common enterprise." Basically, is how it works. I've just mangled it horribly, but that's basically how it works.

So and if you satisfy those four criteria based on subjective objective, but also fact specific analysis, then you may have something called an investment contract, which is regulated in the same way as a security. So with the Dow for example, the SEC looked at that, and they said, it's probably going to be a security because if we look at it, it walked like a duck, waddled around, it looks like a duck and it quacks, this is a duck very clearly because it behaves like one. So as a consequence, the test is deliberately mushy, I don't think the ICO companies really are going to get very much mileage out of asking the SEC to be more specific, because the test is not designed to be specific. It's designed to be general and vague.

And I think there's alternative approaches the UK in the US, it's interesting to see, because so much of our legal system derives it here, derives in the English legal system. There's two different approaches. But that's basically the difference, we have a mushy test in the States and as a consequence of that, I don't think people should expect anything but mushy answers. And that's why the American securities lawyers who I know, are really extremely careful when they're marketing or when their clients are selling securities into the market. There are a list of exemptions, which so the consequence of being an investment contract, is that either you need to have a prospectus, which you would you issue, and then sell in accordance with the applicable regulations, or an exemption or range of them, which don't really bear getting into here needs to apply.

And so if you look at it from that perspective, American securities lawyers are really, really careful about either, "Okay, we need a prospectus, or we're going to stay very carefully within this very well delineated statutory exemption to that prospectus requirement."

Patrick: [00:54:06] I realized that I should have asked you this before we started. I'm curious if you now or have ever personally owned any cryptocurrencies?

Preston: [00:54:14] I have, I owned a very small amount of Dogecoin which I sold. So a while ago and that's it. And there's a reason for it. More interestingly, I was offered a 13,000 eth from the premine, which is now worth about $16.5 million. And I turned it down on the basis that it would compromise my professional independence for two reasons. One at the time, my company was competing with them for Mindshare, so it didn't really make a whole lot of sense to go and take free coins. And two I had an inkling then that I would probably have a big problem with ICOs later down the line as I do now, and I don't think I could really make a coherent argument. I don't think I could turn around on the one hand and say, "I've been made rich by ICO coins." And then on the other say, "But I think ICOs are bad."

So to answer your question, no, I don't play. And ultimately the objective is so that the objective of doing that is that, when you ask yourself in cryptocurrency, what role do you want to play? Right? Some people are traders, some people are economists, some people start businesses, some people are boosters and community managers, some people are lawyers, and I made a decision, you know what? I'm going to be one of them. And in order to do that best or do better than the others, the way to go about it is to be professionally independent, and to give advice based on your client's needs, rather than your own financial interests. There are some lawyers who don't do that, and I think I'm a little uncomfortable with that, but that's why.

Patrick: [00:55:41] With that as a backdrop, what has you most excited, let's say a couple years from now, I think it sounds like you might remain mostly on the sidelines and tell some of this mania has passed. But if you could design it perfectly, what would your involvement be from a legal standpoint or otherwise, once this thing settles in?

Preston: [00:55:59] So I think there's some interesting stuff going on in the broker dealer space. There are a lot of people who are looking at ICOs and saying, "You know what? The infrastructure that's being built here, is actually more effective and cheaper and faster than the paper heavy infrastructure we've been working with previously." So there are companies who are looking to see whether this crypto infrastructure, although it takes some shortcuts on the legal side, they're also taking its total reimagining of how you should move value around and how you should transfer title to property.

So as a consequence of that there are things about it, which are much more efficient than the way we did things before. The idea that for example, let's look at a bond transaction. So a bond transaction has probably five or six banks involved, maybe fewer, maybe three, a bunch of law firms and a bunch of bondholders. And currently, the way that they figure out what the state of play is, is each of them has a paper copy of a big document, which we refer to somewhat offensively as a transaction Bible. And you go and get the Bible and you see all the deeds of amendment and you see what the state of play is and have to go track it down, because the document is stored somewhere in East London, it's a building somewhere.

And then you figure out what's going on based on going through a couple of reams of paper, and then checking in a records on Bloomberg and printouts like that, there is an absolutely, no reason whatsoever, that shouldn't be on a blockchain, which is running between the various transaction parties. So you can see the exact state of the documents, how they've changed over time, what the state of the payments are, whether a payment waterfall has been triggered or not, whether a certain event is taking place or not, what the rating is of that instrument and how that interplays with your waterfalls. So there's a whole bunch of things that you can take that process and make it very, very simple, and much quicker to refer to.

As a consequence, so let's look at it from the perspective of the various parties. The banks, when they're sending notices, that becomes easier. So that's automatic and very, very straightforward. The law firms who will be administering that, those documents in that process, their clients aren't paying $2,000 for some junior associates to look through reams of paper for a day and a half in order to figure out what the state is of a clause three of the trust deed or something like that.

So that's a digit, it's introducing a lot of digitization into areas which have not been digitized. So that kind of stuff where you just have the ability to pull these things up. And in addition, you have a really good, so this is really the most important thing. You have an outstanding chain of evidence, and that's what law is about, right? You have to go prove that something happened at a certain time in a certain way, and you got consent in a certain way, which is why we sit around and shuffle paper and get people's signatures and make PDFs and make 20 copies of them and circulate CDs, it's a nightmare.

So I think all of those kind of old world procedures are very much overdue for an update. And that will happen within the next 10 years is that someone is going to say, "Okay, well we have a service," it'll probably be a law firm to be honest with you, that will turn around and go, "We have a service that we offer, it's digital, it's faster, it's cheaper, you don't pay for as many billable hours. And we manage the ongoing lifecycle the transaction for you. So it just goes in ports straight back in your back office as you'd like." So things like that or there's another project Utility Settlement Coin, which a bunch of banks are doing in London, things like that, I think will be incredibly valuable to the ecosystem-

Patrick: [00:59:09] Can you describe that a little more detail.

Preston: [00:59:11] So Utility Settlement Coin is a project between four or five different banks. I haven't heard anything out of it in a while. But basically, it's four or five different banks who said let's do our own distributed ledger where we settle transactions among each other. And we have a client which does it. So they took the theory that they do a lot of business with one another. And so they said, "Well, you know what? We're just going to have a coin, which does it so that way we don't need that third party service provider, whoever else were using to do it."

Similarly, you could take you could think of something like HSBC and Citi Group, do something like 35% of their FX business with each other. So they could turn around and say, "You know what? Instead of doing this the way we're currently doing it, why don't we just have all of our trades running on this one chain between us? We have perfect visibility, because we're entitled legally to see what's going on between us. And that way we make our record keeping on either side of this a lot easier."

Patrick: [00:59:56] Is that what Ripple maybe is proposing to do between banks, where the insight here is basically, "Look, this kind of indelible, well protected database is a great way if we're doing constant exchange of value for us to do this and just get away with all this lousy old infrastructure." I'm I thinking about that right with Ripple?

Preston: [01:00:17] Not XRP, but Ripple, yes. My understanding of what their inter ledger business was, was that exactly. And so my understanding of most of what their bank businesses is based around the inter ledger. I mean, I don't work there. I don't know what it is. But as a market observer who has a reasonably good idea of what's going on, that was my understanding of what that was for. XRP totally different kettle of fish, speculative mania, all that. So that's a very separate issue.

Patrick: [01:00:42] So you have to describe a little bit about why the constant returning to marmots.

Preston: [01:00:46] Marmots. So marmots are actually my superhero origin story. So I was about 12 years old, and we had this issue with woodchucks in our yard. They were everywhere, they were digging holes, and everything would break-

Patrick: [01:01:00] Where did you grow up?

Preston: [01:01:00] In Connecticut, so Eastern Connecticut. So we had these woodchucks, they were digging up everything and I was handed a rifle and told to do my duty. And after waging of the briefest of wars with these adorable little critters, I just decided I couldn't do it, and they kind of became my spirit animal. As a consequence, that then became a in-joke in my early days that Monax which was at the time called Eris industries, one of the three co-founders is a quantum mathematician. And he and I were just trying to explain quantum information to me. And I was like, "What is this superposition?" And everyone understands it now because there are enough YouTube videos, but nobody understood it back then. That was ancient history.

And so he tried to explain it in terms of giving a cookie to a marmot because he knew I like marmots. So it he said, "Well, you're giving the cookie to the marmot, you're not giving the cookie to the marmot. You're giving it to the marmot and not giving it to the marmot and you're doing neither at the same time." I was like, "Well, this makes perfect sense." And so if you explain things in marmot terms, I can understand software, this is perfect.

So anyway, it just became an in joke, it then spun wildly out of control. And I decided to persist doing it despite the fact that it drove people crazy. It drove my investors crazy, it drove the market crazy, it drove people on Twitter crazy until eventually they broke, and they started liking it. So that was my objective there.

Patrick: [01:02:12] If you could have everyone out there that's... You mentioned that the blockchain is a journey and that's a really good way of putting it. I certainly went on it, where it's initial appeal, and just the different angles that you can explore behind it seem endless, right? It's this endlessly fascinating topic. So it takes a long time to even understand what the hell it is you're looking at. But for those out there that are let's say earlier on in that journey, are there any reference materials, whether it be a post, a book, an idea, a person, a YouTube clip, it could be anything that you think might be most just generally valuable?

Preston: [01:02:44] No, there aren't. I would say there really aren't any reference sources which are valuable, because the important thing when thinking about blockchains, is knowing your business extremely well, knowing what you do backwards and forwards. And then asking yourself a very simple question, what does a distributed system that everyone can read have to do with what I'm trying to accomplish here and doesn't make it more efficient. So and it's really that simple. So you can go and dive in, and read 100 different books by 100 different authors, most of whom have no idea what they're talking about, and have not built, deployed or designed a single blockchain system in their entire lives. And they'll sit there and tell you how it's going to revolutionize everything.

But fundamentally, the skeptical view of this is to say 99.8% of what's going on in blockchain right now is garbage. And the 0.2%, which isn't garbage, is when someone understands the use case, backwards and forwards. And they figured out why they want a distributed system there. For me as a lawyer, that is the automatic transaction Bible makes perfect sense. I know this space very well. I've said this is an idea which potentially could get some traction in 10 years. There are people in supply chain, Leanne Camp of Everledger, she understands diamonds backwards and forwards. And she said, "You know what? A distributed system automates these relationships really well."

Patrick: [01:04:08] Can you describe that in a little bit more detail. Maybe I don't know if you know the particulars of that diamond example. But supply chain is something that my ears have been perked to that it started to come up more and more as an interesting use case for this. So maybe describe why that's interesting.

Preston: [01:04:21] Apologies to Leanne if I mangle her startup, but my understanding of what Everledger does, by way of, so generally supply chains are you've got a box of something, and it's got to get passed through a dozen different hands before it arrives at your doorstep. You want to know at every stage what's happened to it, what the condition of the thing is, because what you're getting and what you're liable to pay for, depend in large part on how it gets to and in what condition.

So it's important to track what's going on with things as they move through the stream of global commerce. Everledger in particular, looks at diamonds in that diamonds apparently all have registration numbers and they can be identified by references size, light characteristics, refraction, whatever, some scientific magic I don't understand. And sometimes people claim because they say, "Oh, well my house is broken into my diamond was stolen," or diamonds actually do get stolen and then they turn up later at some shop down the road and they get resold again.

So Everledger, my understanding is that it's a database which in designed to link up the police, the shops, and insurers, so that you can figure out if someone has made a claim against a diamond and they said, "Well, I've lost my diamond," "Okay, we'll pay at $6,000 to you, here you go, go away." Two months later, the same thing turns up in the shop, you go and you interview the shopkeeper who brought that in while it was Joe Bloggs' his wife, who brought it in and turns out she was the one who made the original claim. You do that and you reduce your insurance fraud.

So it's a way that you can spread that out and make sure everyone's looking at the same data, which is verified. And they say, "Well, we've identified that this diamond originated here, we can track where it went. And in addition to that, we know if it's been stolen, someone can report it stolen and we can go and put a black mark against it. So we can track what happens to it when it turns up later on down the line." So it's a way of getting better information about what's going on in the supply of diamonds in a particular place, so that you can avoid insurance fraud. That's my understanding.

Patrick: [01:06:15] Why is it being distributed an advantage there? Why couldn't that just be a central data provider?

Preston: [01:06:22] Primarily political reasons. So if you have a central data provider, my experience with the banks is that really bothers them that you're basically that's just a cloud service. So what they would rather do is they'd rather say, "You know what? There's a bit of public information, which everyone is entitled to in this consortium that we're running. And so in order to achieve equality of arms, we're willing to share that data, as long as we have a stake in operating it." But if for example, let's say Deutsche Bank said, "You know, we've just built this new platform called Deutsche Note, and we're going to go run all of our transactions through it. And guess what guys, you can outsource all your stuff to as to."

Well you know Bank of New York is going to look at them and go, "No, absolutely not. We're not letting you run the system, because then you have all of the power," but at the same time, they still have an interest in coordinating their activities. So it's really political more than anything else. How do you get two organizations to trust each other over information that they're passing back and forth very frequently, without having the issue of one of them being responsible for all the infrastructure?

Patrick: [01:07:19] So if you're firmly in the bear camp on, let's say, the investment prospects of the various cryptocurrencies, but you had to identify someone that you would think of is in the bull camp that you respect or you think is thoughtful?

Preston: [01:07:31] Ari Paul.

Patrick: [01:07:32] Ari.

Preston: [01:07:33] Hands down. One of the more thoughtful guys I've met. He knows what he's doing. And actually, surprisingly, a buddy of mine from high school. A guy named Chris Dan, and I had no idea-

Patrick: [01:07:45] Oh, sure. He wrote the Ethereum book, right?

Preston: [01:07:47] Did he?

Patrick: [01:07:48] Yeah, I'm pretty sure he wrote a book on Ethereum.

Preston: [01:07:50] So he knows this stuff. When we cross paths about eight or nine almost a year ago now. And I was like, "Dude, like seriously, what?" And so Ari and Chris both know what they're doing. So I'd say in the bull camp, those are the two guys that I'd point to.

Patrick: [01:08:04] So a good almost bow tie on this whole conversation, because Ari was the guy that kicked off my entire journey here. Everyone listening will know that because he and his partner Matthew, at Block power are the two that basically queued up my whole journey, right? So introduced me to everyone that I should talk to. So it's been fun to do that with those guys. The closing question that I ask everybody, is for the kindest thing that anyone's ever done for you.

Preston: [01:08:27] Kindness thing anyone's done or said for me was a friend of mine in New York City. When I left Monax earlier in the summer of 2017, a buddy of mine was like, I was a bit disappointed about the circumstances of my departure. And one person who knows who he is, kind of shook me out of it and was like, "Dude, get it together, get writing again." And this is before I hadn't blogged anything. And you can tell when I'm in a bad mood, because I haven't written anything in six months.

And so he's like, "Dude, get it together, whatever." And we went up to Pork Fest in New Hampshire, which is a libertarian sort of anarchist festival and had a great time. And I would say that person is the one who, that shaking me out of my... Getting me back to my senses, that's the nicest thing anyone's done for me in the space.

Patrick: [01:09:13] Well, this has been a refreshing counterpoint to most of the other explorations I've done of cryptocurrencies and blockchains, really illuminating. So thank you very much for your time.

Preston: [01:09:22] Thank you. Pleasure.

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