‘Back to the basics’: What the SEC’s ruling on DAO tokens mean for the industry

In a ruling issued Tuesday, the U.S. Securities and Exchange Commission finally came out and said what the blockchain community has known all along: DAO tokens are securities and are “subject to the requirements of the federal securities law.”

The DAO, which stands for Decentralized Autonomous Organization, was the automated, leaderless ethereum-based funding vehicle that suffered a massive hack last year after raising millions of dollars from investors in the token sale. This ruling could be “the end of the beginning phase for blockchain,” said Emin Gun Sirer, associate professor at Cornell University and co-director of the Initiative for Cryptocurrencies and Smart Contracts.

“What we were beginning to see with the ICO craze was every Jack and Jill coming up with an old idea, wrapping it up in a token and issuing securities in a virtual company of some kind,” Sirer said. “I hope we will see a return back to the basics. There’s a lot of infrastructure work to be done. People will start to take a close look at their own ICOs and quite a few will fail these rules the SEC applied.”

The rules follow a three-pronged test known as the Howey Test. A token is a security if they’re selling something for money; are they promising future profits; and the future profits predicated on the efforts of other people and third parties.

Here are three key takeaways from the ruling.

This doesn’t change much
If anything, the ruling was “a reminder” of something people already knew was coming and maybe were surprised was taking so long, according to Angela Walch, an associate professor at St. Mary’s University School of Law and research fellow at the Centre for Blockchain Technologies at University College London.

“It’s not like they came out with a new conclusion of law or policy, they reminded us that the existing policy applies to these new forms of fundraising,” she said. “The only difference is that we’re doing it in a technological way and calling it something different.”

The SEC tends not to give guidance on whether something is a security or not so as not to discourage innovation. In the guidance it didn’t even define what a security is or isn’t. The fact that the DAO tokens are treated in the eyes of the SEC as legal securities doesn’t mean the market is going to suddenly shut down. People that want to continue with their ICO plans can probably do so — in a way that’s compliant with U.S. securities laws.

There is some uncertainty as to what will happen to token sales that will happen in the interim, Walch said. Those that occur after this point are clearly on notice and need to figure out how to comply with securities law. But there’s some ambiguity among people that launched their token sales between the the time of the DAO and now. They’re not necessarily off the hook.

“I think the future is bright for non-securities tokens,” said Marco Santori, a partner at law firm Cooley LLP, tweeted Wednesday. “This is the first step in a critical maturation process.”

This isn’t the end of ICOs
If anything, the guidance could slow down the pace a little bit, according to David Lucking, a partner at law firm Allen & Overy. There has been a lot of focus on ICOs in the last year, and many people have set them up without really considering the legal ramifications.

“The SEC is sort of putting the market back on notice: the tokens themselves can be treated as securities, and the platforms on which these tokens trade may be treated as securities exchanges. Both things are regulated in the U.S.,” he said.

Of course, not all tokens are securities. The SEC was pretty clear it would take a case by case approach to this kind of activity, “depending on the particular facts and circumstances,” making it a nice time to be a lawyer versed in crypto.

“It will bring back to the forefront the need to involve lawyers, which for so many people is not that desirable because obviously, the beauty of blockchain and distributed ledger technology is somewhat to disintermediate established ways of doing things and established market participants,” Lucking said. “This reins that in a little bit.”

Sirer highlighted the quick emotional reaction by many in the blockchain community — some gloated about having seen this coming, some worried all tokens were securities and that this might affect their ICOs — to guidance on a narrow class of activity pretty specific to the DAO. The SEC could issue other findings — that will inevitably come later, but for now, not just any ICO is binding by the SECs recent findings.

“We’re living through a time of ICO mania,” he said. “There are worthless ICOs, there are scam ICOs and all sort of other rogue ICOs that shouldn’t exist. But this ruling doesn’t say anything about them — this is a ruling on the DAO and things like the DAO.”

Implications for bitcoin and ethereum
Many people that read that guidance couldn’t help but notice the SEC’s choice identifier of ethereum as a “virtual currency” as opposed to a virtual “token” or “coin.”

“My reading of this is it has no implications for the underlying infrastructure,” Sirer said. “Currencies themselves are not regulated by the SEC, securities are regulated by the SEC.”

Plus virtual currencies in the U.S. got their ruling in March 2013. It’s legal to own and transfer them without a license (although the exchange doing the actual transferring may need one).

Why one VC is bullish on ICOs

In the past three months, companies have raised more than $300 million, not through venture investors or banks, but from token sales, also known as initial coin offerings.

Venture capital has become synonymous with innovation and wealth creation over the last half century. Today, corporate VCs (established corporations that with dedicated funds for external startup companies) are on the rise; the number of active corporate VCs per quarter more than doubled between 2012 and 2016, according to CB Insights. Enthusiasts of token sales are optimistic that they can unseat venture capitalists, as an investment vehicle that removes the need for the middle man and provides more liquidity.

The VCs themselves haven’t shown much concern over that idea (it may be too early for that). If anything, some are looking beyond that detail at all the possibility for innovation.

“It’s much like you agreeing to pay in advance a two-year subscription to the Wall Street Journal or New York Times,” said Ryan Gilbert, partner and founder of Propel Venture Partners, the BBVA Ventures spinoff that launched as its own LLC last year, at the Tearsheet Money Conference this week. “The subscriptions we used to know are the coin offerings of today.”

Of course, it’s not clear if the tokens sold constitute securities. The Securities and Exchange Commission hasn’t issued any formal guidance on tokens as securities and regulators tend to take a do-no-harm approach to new business concepts and technologies that haven’t proved harmful.

“Yes, what’s happening today might be controversial,” Gilbert said. “But when regulators learn more about what’s truly happening, they’ll recognize… what’s going to help deliver financial services to everyone at the lowest possible price, how are we going to truly have transparency, is knowing both where a transaction starts and ends and what the true costs are going to be.”

Gilbert’s stance reflects a growing interest in public blockchains by bank executives as well. A Cognizant survey released this week of 1,520 executives from 578 financial services firms shows 86 percent see public blockchains becoming more prominent in the next five years; 80% said the same about private blockchains.

In the original bitcoin blockchain, transactions are recorded on a public ledger anyone can see, although users are pseudonymous, identifiable only by alphanumeric addresses. That doesn’t mesh well with the need for privacy in high-stakes transactions between massive companies, which is why banks — which were initially hostile have sought “permissioned” blockchain-like solutions that allow for more privacy in terms of how data is stored and who can access it.

At least two of Propel’s portfolio companies have raised money through token sales. For example, the blockchain-based digital advertising system Brave “managed to raise $24 million in about 29 seconds,” Gilbert said.

In financial services, the token sale opportunity could perhaps manifest in payments, through a bank transfer service that uses these types of tokens as a means of compensation.

It’s hard for the everyday person to justify paying $17 to wire $100 from the U.S. to Mexico, especially when the cost of that wire probably looks more like 75 cents. But using these kinds of tokens, the supply and demand sides can come together to “dictate the true price of that token for the value exchange… whether that payout point at Guadalajara or Mexico City actually has that cash from the sales of the day to disperse to you as a recipient.”

Other investors are more cautious. Mike Sigal, a partner at 500 Startups, didn’t comment on his investments but noted that one of the hardest things for an early stage company to do is acquire customers and activate the entrepreneur’s community, and that a token sale could be a tool for it to truly get its community engaged, speaking at the Bloomberg Bloomberg Buy-Side Week Focus on Fintech event this week. For Citi Ventures, they’re still a solution in search of a problem. Arvind Purushotham, the group’s co-head, said it looks at blockchain investments with direct applicability to its business. It’s an investor in Chain, but hasn’t made any cryptocurrency investments.

The early-stage fund Future\Perfect Ventures has several portfolio companies now planning ICOs, said Jalak Jobanputra, its founder and managing partner. But it’s a Wild West, and it’s unclear whether these token sales have real technology behind them or if it’s just a quick way to make money and take advantage of momentum, she explained.

“There will be something really lasting out of this but there will be a lot of catches in the process,” she said. Tokens related to the business are one element of it but some companies want to raise just to have a capital raise. You really have to dig in and see what you’re going to own… It would be dangerous for these companies if there was immediate liquidity or lack of liquidity. All of those terms are up in the air right now.”

Blockchain Capital’s Spencer Bogart: ‘Wall Street should be paying attention to blockchain right now’

What do you do as a sell-side analyst when you write the seminal research report on Bitcoin? You join a new type of venture capital firm that invests solely in the blockchain ecosystem.

That’s what Spencer Bogart, head of research at Blockchain Capital, which has made dozens of investments in blockchain did. Bogart was previously at Needham and Company, joins us on this week’s episode of the Tearsheet podcast.

We talk about the transition from the sell-side on Wall Street to venture capital and how his experience impacts his research. We also discuss his newest fund which was funded in its own cryptocurrency, BCAP. This form of investing, still really just an interesting experiment, could potentially change the mechanics of investing in private companies.

Subscribe: iTunes I SoundCloud

Below are highlights, edited for clarity, from the episode.

What was it about Bitcoin that caught your attention when you were on Wall Street?
“Like a lot of people, I looked at Bitcoin as something highly unlikely to succeed, but also very intriguing intellectually. Eventually, it finally got to a point with Bitcoin and its underlying technology that it made sense for a company like Needham & Co. to get out in front of the opportunity, start meeting all the companies in the space, and become a thought leader.”

The transition from sell-side research to venture capital
“One of the hardest things going from a traditional sell-side research role where you’re covering large publicly traded companies to a venture role is that you really have to go without a lot of data in the beginning. With a sell-side research approach, I would start with a quantitative approach when analyzing a company, look at its multiples and growth, how it compares to its peers, and then layer on a qualitative aspect of whether we believed a company would continue to grow and whether it has a sustainable advantage.

With venture capital, it’s the exact opposite. You have to start with a qualitative aspect and then layer on a quantitative approach when thinking about an investment opportunity. We call ourselves ‘stage agnostic and seed biased’. The vast majority of our investments were made in seed and Series A rounds. Companies at this stage just don’t have a lot of data to work with.”

Why should the vp of marketing at Goldman Sachs care about blockchain and Bitcoin?
“We look at blockchain as fundamentally changing the way value is transferred in a digital world. If you think about some of the other ways to transfer value digitally, like Paypal, they generally have made it easier to use legacy infrastructure, but they haven’t created new pipes. Blockchain is that new infrastructure and architecture for value transfer.

For a company like Goldman Sachs, it’s definitely time to be diving in to blockchain. It could still be a year to five years out, though, that blockchain is knocking on their door, ready to disrupt their business.”

Blockchain Capital’s new venture coin
“For our third fund, we did what we believe is the first fully-compliant Initial Coin Offering. We sold tockens, BCAP, the ticker for our ICO, on a one-to-one basis with the U.S. dollar. Doing it this way, we raised capital from over 700 investors around the world in an average check size you wouldn’t normally see in a venture fund.

We wanted to practice what we preach and use the technology we advocate so strongly for to disrupt our own industry. Venture capital suffers from two primary problems: access and liquidity. VC has typically been the domain of privileged endowments and institutions. And capital is normally locked up for 5 to 10 years. Our tokens will be traded in a way that their holders won’t have to wait this long to sell their investments.”

 

How Fidelity is experimenting with bitcoin

Fidelity Investments may be one of the few incumbents that are bullish on bitcoin.

It sees “a future where bitcoin and blockchain thrive,” according to CEO Abigail Johnson, speaking Tuesday at the Consensus conference in New York. “We still think this scenario has a reasonable chance of coming to pass — despite what the skeptics say.”

This week, the price of bitcoin shot past $2,000 for the first time and is currently trading at about $2,200. Ethereum increased 1400 percent in the last three months and is now trading at about $180 — which community observers and conference attendees say has much to do with new interest in ICOs. But despite the growing interest digital currencies and public blockchain networks, few if any financial institutions haven’t come out and said they’re interested in working with them, instead focusing on the technology that powers them: blockchains, distributed ledgers, smart contracts — for their industry or organizations’ own needs.

In the original bitcoin blockchain, transactions are recorded on a public ledger anyone can see, although users are pseudonymous, identifiable only by alphanumeric addresses. That doesn’t mesh well with the need for privacy in high-stakes transactions between massive companies, which is why banks have sought “permissioned” blockchain-like solutions that allow for more privacy in terms of how data is stored and who can access it.

Judging the future by the present is not a productive approach, Johnson said.

“If you only look at this technology through the lens of the problems that exist today you won’t find a lot of compelling use cases, at least not that can be implemented at scale,” she said. “If you’re looking for bitcoin to beat Visa at the point of sale today you’ll be disappointed. If you’re looking at this technology as just a faster settlement system for financial transactions you’ll also be disappointed. But I’m still a believer.”

Johnson’s remarks aptly represented the mood at this year’s conference, the third for Consensus, and industry-wide. While the energy of the inaugural event came largely from crypto-enthusiasts, last year’s was filled with bankers in suits, on and off the main stage. Attendees tripled from the first year to 1,500 in the next; about 2,500 came out this week, with balance interest in private blockchain networks for highly regulated industries and a rebound in interest in public blockchain networks.

Fidelity has built proofs of concept for bitcoin micro transactions, set up a small bitcoin and ethereum mining operation “in the spirit of learning, but miraculously we’re actually making a lot of money,” she said. It enabled bitcoin payments in the Fidelity cafeteria — and had fewer than 100 employees purchase bitcoin. It has also partnered with bitcoin wallet Coinbase to allow clients to contribute bitcoin to there donor advised funds accounts with Fidelity Charitable; it has facilitated more than $8 million in bitcoin contributions through that platform.

Fidelity also gave its employees the ability to view their Coinbase holdings on Fidelity.com and will be rolling out the same functionality to its customers “soon,” Johnson announced.

It was through the hands-on experimentation — testing the Coinbase user experience, making purchases with bitcoin and even trying to make returns — that the future-present dilemma became clear. A lot of the work with blockchain technology, in financial services or otherwise, is about the future. But in the learning process, people naturally try to compare their experiences with the present.

“When people are exposed to new concepts they need to make sense of something they don’t already have a mental model for,” Johnson said. “Our research teams noticed what was happening when people encountered their recovery phrase,” a random string of words to be written somewhere and stored somewhere that acts as a backup of a user’s funds, “for the first time. They tend to struggle because they don’t have a mental model for this kind of thing.”

Fidelity found three types of reactions: one in which people reacted by trying to compare the situation with something they’re previously familiar with — for example, treating the recovery phrase like a password and expecting there would be a Forgot My Password button they could press — one in which a fair few were able to develop a new mental model and one in which the users quit and never adopted the technology.

Usability is a challenge, Johnson concluded.

“In the same way users we studied defaulted to known mental models, all the regulators will go through the same kind of process and it will cause some growing pains,” she said. “Too often we see bitcoin and blockchain technologies as solutions in search of a problem. We need them to be more user friendly — not just technically better.”

WTF is an initial coin offering?

There’s been a lot of talk lately about initial coin offerings, known as ICOs. Enthusiasts tout ICOs as the future of venture investing in the blockchain world.

“The precedent we’re about to establish will be the future of the entire sector. VC as an asset class has delivered good returns historically, but they’re locked up for five or 10 years and people aren’t happy with that level of illiquidity.” said Brock Pierce, chairman of the Bitcoin Foundation and managing partner of Blockchain Capital.

Despite that, the idea has its skeptics. We break it down.

Wait, so what is it?
It’s basically a source of funding for new blockchain-based business endeavors. When the decentralized network is created, the startup behind it can sell tokens early in the process for an amount based on what it thinks it’s worth at that stage, all in order to raise money for the continued development of that network or application.

ICOs are similar to any other investment and often likened to IPOs in that the investors hope to make good returns on their investments and in that the startups behind the ICOs are trying to raise money to grow their endeavor. It’s becoming more typical for startups to produce some sort of documentation that describes their background and plan for their initiative, according to Angela Walch, associate professor at St. Mary’s University School of Law and research fellow at the Centre for Blockchain Technologies at University College London.

A new investment vehicle? Big deal.
Revolution by democratization of course. ICOs allow entrepreneurs to raise money from retail investors – so any Joe Schmoe that wants that want exposure to the early stage ecosystem can diversify his investment portfolio. (Okay, not just any interested investor, but more on that in a sec.)

Also, the tokens are liquid assets. You can convert them to cash or other cryptocurrencies quickly instead of having your money tied up for a number of years.

“The problem most startups have is a general lack of liquidity and all the market ecosystem participants are negatively impacted by that lack of liquidity,” Pierce said. “If you’re an early founder, the likelihood of being able to sell any of that stock prior to the business becoming very successful or very large is low.”

Sounds kinda sketchy…
There’s been a lot of debate about whether the tokens sold in an ICO legally constitute securities. There are different ways you can structure them to make them look more like a security, or less. The Securities and Exchange Commission hasn’t issued any formal guidance on crypto-tokens as securities. Regulators don’t typically jump in to regulate new business concepts and technologies when they haven’t had significant traction done any “real” harm, said Carol Van Cleef, a partner at law firm Baker & Hostetler LLP.

“In such circumstances it becomes increasingly difficult for policy makers not to pay attention to how current laws may apply and consider what steps, if any, they need to take,” Van Cleef said.

There are many unknowns: are the people buying these tokens considered investors under the securities laws? That would depend on whether the token is determined to be a security. Is there someone that can be identified as the one organizing and executing the ICO?  Who is responsible for the ICO?

“Those organizing ICOs over the years have been increasingly mindful of U.S. laws and the uncertainty as to whether they apply,” she said. “They have taken steps to make sure they don’t run afoul of those statutes in the event ICOs are determined to involve the offering of securities. A primary technique for doing that is offering securities outside the U.S. to non-U.S. residents.”

Is someone actually doing this?
Blockchain Capital is aiming to be the first in the world to do it “the correct way,” in compliance with regulation, Pierce said. That means it’s acknowledging the tokens as securities and investors will hand over all the Know Your Customer information required to show they’re accredited investors – that mostly matters in the U.S.

“Instead of creating these convoluted structures to circumvent securities law, why not just face the regulation head on?” Pierce said.

So it’s incorporating its $10 million ICO in Singapore. The sale begins April 10 and there are 99 seats. U.S. users will have tokens locked up for one year; international users will have their tokens locked up for 40 days.

Who cares and why should I?
Developers, mostly, unless you’re a crypto enthusiast eager to invest.

Historically, open source software projects succeeded in people’s own time because no one paid developers to build – and that model of innovation has been celebrated. Bitcoin changed that thinking when it entered the scene, Walch said, and now ICOs are a way developers can demand compensation for what they do.

“Bitcoin as an open source software project is high stakes in that it is transferring and managing things that have real value,” Walch said. “Bitcoin had the luxury to grow up before a lot of people noticed it. Now blockchain is accepted as a value transfer system and anyone building one now is doing it for that reason. The ICO model isn’t anything revolutionary, it’s people trying to do something in a loosey goosey way for a high stakes endeavor.”

And as the ecosystem grows it gets harder to ignore how much developers of these public blockchains function like fidicuiaries, she added.

“You’re putting a lot of trust in [developers] to make sure it keeps operating, essentially to do things right and not cheat you,” she said. “It’s the same situation with these ICOs: you can’t escape accountability for doing something high stakes with other people’s money. But that’s what’s happening with ICOs and regulators won’t overlook it for very long.”

C’mon. Is this really a thing?
Who knows. Marco Santori, a partner at law firm Cooley LLP., said in the last two months, 60 percent of inbound interest in his lawyering services has been related to token sales.

“It could be a whole new way to raise money,” Santori said. “The last new way of fundraising we saw was Kickstarter; this could be Kickstarter for decentralized networks. It is a significant development in the course of private finance and frankly public finance for that matter.”

This may sound like the earlier days of bitcoin Ponzi schemes and pump-and-dumps (when the “real world” corporations realized bitcoin had a PR problem they moved the conversation away from crptyo-anything to “real world” applications) but blockchains in the broadest sense of the word have come a long way in just three years. So when you take into account how many people are actually building, investing in and using these decentralized networks, it’s probably a bigger number than it seems.

But not all business models are amenable to the token sale approach, he said. For some business models there’s really no way to avoid the securities laws.

“For a lot of business models you really have to go and raise venture capital,” he said. “You can’t just bolt on a token to your business model and try to raise money by selling it and trying to avoid securities laws.”

Hi 5! The top five fintech stories we’re following today

top 5 weekly fintech stories

Ecommerce moves from products to subscriptions
When you peel back the covers to take a look into some of the world’s top product companies like GM, it’s likely that they’re thinking about their future businesses entirely differently. New data shows that subscription-based companies are growing nine times faster than those in the S&P 500.

Zuora enables firms to transition their businesses to subscription services, away from products. Companies like NCR and Informatica work with the tech company to do way more than just process recurring payments.

  • Read more: Subscriptions could be part of Daimler’s strategy — it just acquired a bitcoin payment company and plans to launch Mercedes Pay

Improve healthcare payments, improve healthcare
Healthcare payments aren’t healthy but there are cures being worked on. One such solution, by fintech firm, Simplee, and used by 1000 healthcare providers, designs a more enjoyable payment experience for patients. Patients get more choices and flexibility in how and when they pay, boosting revenues.

  • Read more: Not all opportunities in insurtech have to do with health insurance. Some experts believe there’s a trillion dollar opportunity in…solar insurance?

The future of fintech
Reading the fintech tea leaves isn’t easy but experts in the field attempt to figure out where finance and technology are headed. This week saw a few of those types of analysis:

  • Wells Fargo Digital Lab offers a front-row seat to the future of banking (Finextra)
  • Where a leading VC still sees fintech opportunities (TechCrunch)
  • Deutsche Bourse turns to fintech partners to build ‘Exchange 4.0’ (Fintextra)
  • Online student lender CommonBond’s CEO offers 5 fintech predictions for 2017 (TechCrunch)

Bitcoin and blockchain grow up (well, sorta)
Blockchain technology could help the world’s largest investment banks cut their infrastructure costs by between $8 to $12 billion a year by 2025, according to a report by Accenture.

Not so fast, though. Technology and policy holes still enable opportunities to be exploited, like Chinese high speed traders are doing with Bitcoin. “It’s the golden age to be in the bitcoin market, because it’s imperfect,” said Zhou Shuoji, a former IBM technology consultant whose firm, Fintech Blockchain Group, runs a bitcoin hedge fund and venture capital fund.

Banks, heal thyselves (before your competitors do)

customer loyalty in banking
Banks are losing the battle to get more business from existing customers. Bank customers clearly display a lack of loyalty to their primary bank. In the U.S., less than half the time do they new financial products from their primary bank.

The U.S. head of Bain’s banking practice joins Tradestreaming to discuss what banks can do to counter hidden defections.

SAP’s Kris Hansen on blockchain: ‘Put the trust into the algorithm’

In our coverage of bitcoin and supporting blockchain technologies, it’s clear that the hype way overshoots what’s actually happening on the ground. So, to better understand how companies are actually interacting with distributed ledger tech, we went to Kris Hansen.

Kris is a senior principal at SAP, focused on financial services at the global software player. In his role on the value engineering team, he works to identify ways that digital approaches can be used to find interesting opportunities to create disruptive business value. A self proclaimed “recovering” chief architect of a bank, he brings an interesting perspective on changing business models and technology platforms in financial services.

Subscribe: iTunes I SoundCloud

Below are highlights, edited for clarity, from the episode.

The challenging transformation of today’s banks

I often refer to myself as a recovering chief architect from a bank. It can be a tricky job. You have all this technology complexity and legacy investment. And then you have the business showing up and saying it wants to do something completely different. You’ve got to somehow get this massive legacy shaped and formed in the right direction to go forward. Occasionally, you get an opportunity to transform and rethink the legacy. But that becomes a challenge in managing scope and finding a solution that’s really going to make a difference. You’re on the hook for feasibility (the stuff has to work) and the business outcomes (the business has to be happy with what they get). Being a bank architect is a tough job.

Preparation for the coming blockchain movement

Personally, I’m a tacit learner. For me to understand Bitcoin and Ethereum, I set up a node to see it and understand it. Businesses need to start getting hands-on. Understand what cryptocurrencies are and the differences in the platforms. From there, you have to start thinking about what it would take to connect the existing world to this new world. Quantifying that gap and determining what’s involved to change is where organizations should be at this point.

Industry cooperation around distributed ledgers

I’d really like to see us get to industry-wide collaboration. One of the great advantages of the consensus protocol is that we can establish trust where trust doesn’t need to be explicitly built between counterparties. We can put the trust into the algorithm. We can put the trust into cryptography.

I don’t see a lot of that happening with most of the enterprise adoption of these platforms. We aren’t there, yet. There tends to be more of a closed network. Some of it is the challenge of building the network and getting people to the table and agree on how to run these proof of concept projects. It’s hard enough to get multiple divisions in a bank to work together. Multiply that by 40 and you can see the challenge with some of the blockchain consortia. They have a lot of meetings. What we need to see is some of the bureaucracy-breaking concepts built into the platforms. Instead of having meetings, let’s lean on consensus technology to agree on how we’ll form this consortium. So far, the technology hasn’t helped align these groups.

Moving beyond the blockchain hype with MIT’s Dave Shrier

Blockchain may be nearing the peak of its hype cycle but much of the hubbub is just that — top financial firms are still just testing distributed ledger technology, trying to figure it out and understand its potential. Few understand how the world is changing like David Shrier.

David is the managing director of MIT Connection Science and the author of a new book called Trust Data: A new framework for identity and data. You can get it at Amazon: a.co/7yBpXBj

David Shrier presented at the 2016 Tradestreaming Money Conference held in NYC last November. The audio you’re about to hear was part of his talk on moving beyond the blockchain hype.

Subscribe: iTunes I SoundCloud

Below are highlights, edited for clarity, from the episode.

Understanding blockchain and its potential

What is blockchain? Blockchain’s a ledger, a receipt. A lot of financial services firms are essentially record keepers. An order ticket is just the front end of a ledger process. Blockchain is interesting in that it can take a lot of costs out of the complex systems we have to govern today. But we’re interested in even bigger problems. One of them is the big data problem. Sensitive personal information is getting hacked frequently and the problem is only getting bigger.

On the other end of the spectrum, data is more valuable when it’s shared. Wouldn’t it be great if 30 of the largest trading partners could see their aggregate risk exposure to an individual security without revealing any individual position? But we’re not there yet. We’ve taken our old way of doing things in the analog world and made them digital — this is the analog-digital gap.

MIT's Dave Shrier presented at the 2016 Tradestreaming Money Conference
MIT’s Dave Shrier presented at the 2016 Tradestreaming Money Conference

Digital identity in an analog world

Our current expensive model of identity is still totally based on analog paradigms. Our parents attest to our birth and eventually you get a birth certificate that can be easily forged. We’ve had genetic testing for decades but we still rely on this analog attestation model.

Our existing models are centralized, easily forged, and costly to manage. The US Treasury would love to see more access to the unbanked and underbanked while banks complain that regulation is too expensive to service these people. The mobile phone and behavioral biometrics are really hard to duplicate. If you extract all a user’s patterns of behavior using a phone (like what angle they hold it at or who they call frequently), you could extract a digital fingerprint that could be thousands of times more secure than a password.

OPAL Enigma

The Trust Data system we’re proposing addresses the problem that we need better systems as we move from an analog world to a digital one. While we want to share more data, we need to tighten the privacy around it. MIT’s OPAL/Enigma is one of these systems.

OPAL stands for open algorithms and it’s a very powerful idea. With OPAL, you bring the code to the data rather than bringing the data to the code. Instead of centralizing data, this is more secure because you can leave the data where it’s stored and machine learning allows questions and answers to come in and out securely.

In terms of security, Enigma would need over 1000 private keys or passwords to be able to hack into it. Enigma’s data is distributed and encrypted but you can still make useful sense out of it while it’s encrypted.

 

November Blockchain Hype Meter: Fleeing R3

blockchain hype meter

The biggest story regarding blockchain this month were incumbents leaving the R3 blockchain consortium. Sure, there were some other interesting happenings, but when three big financial institutions leave a consortium, it overshadows other happenings.

Goldman, Santander, and Morgan Stanley leaving R3 is bad for blockchain hype, but when looking at the details of why these companies left, it wasn’t because of loosing faith in blockchain or trying to go another route. It was, to the shock of no one, about money.

R3 had asked members to invest in a $200 million series A round to be a part of the consortium. A few institutions balked at the idea of forking up a large investment for a product that wouldn’t be their own, and left R3. In response, R3 lowered its funding goal to $150 million and changed the terms of the round. Reports have emerged that member banks are interested in investing a total of $59 million, a third of the lowered funding goal.

Though three incumbents leaving R3 is a big deal and hurts hype, what does it mean for the future of mainstream blockchain use?

On paper, the consortium model sounds like a good idea for blockchain. A bank that moves to a distributed ledger for transactions between its own accounts isn’t changing much from the current system we have today. Just like banks agreeing to move to SWIFT, getting the most out of blockchain will only happen when a majority of institutions or retailers are connected via blockchain(s). So building blockchains as a group effort may be the best way to set up financial networks for the long run, and a consortium is smart way to accomplish that goal.

On the other hand, companies may not want to put the cart before the horse. We’re still at the early stage of blockchain, and institutions may want to dip their toes slowly in the water of blockchain. Experimenting with blockchain inside a company and then figuring out a way to build it out may be the more realistic strategy. Once institutions get secure with blockchain, they can start to slowly bridge gaps between private blockchains, linking institutions when they want to, and working out how to bridge the gaps with APIs and other technology.

Though the consortium model may be the better long term solution, just because companies are leaving R3 doesn’t spell the end for blockchain. Money was a big factor, and companies that left the consortium haven’t abandoned blockchain. It just may take a little more time for banks and institutions be linked together via a blockchain.

November Blockchain Hype Meter

(In case you missed the October HYPE meter, click here)

It was a pretty quiet month for blockchain hype, with only 33 articles on the subject appearing in the publications we track. Though there was a lot of negative HYPE this month, there were still a few more positive articles than negative ones.

Sweden’s central bank is considering adopting a digital currency. Walmart wants to use blockchain to track food safety. And the UK’s Royal Mint is working on creating a blockchain powered marketplace to trade gold.

Most of the negative articles had to do with the exodus out of R3. Along with that, Ripple CEO Chris Larsen stepped down this month. Finally, the IRS started getting involved with tracing Bitcoin users, which is good for making Bitcoin more mainstream but bad for HYPE.

Notable HYPE articles (19 total)

  • How blockchain will change your life (WSJ)
  • Blockchain technology branches out from finance sector with EY deal. (CNBC)
  • Ones to watch: The rise of online-only money (FT)
  • Opportunities for blockchain in Asia (Bloomberg)

Notable Not HYPE articles (13 total)

  • Bitcoin was supposed to change the world, what happened? (CNBC)
  • IRS is seeking tax evaders who use bitcoin (NYT)
  • Has the blockchain hype finally peaked? (FT)
  • Hong Kong central bank flags blockchain money laundering risk (Bloomberg)

November HYPE meter score: 24 (d3fc0n 2: Is there a DAO to invest in?)

Change from October: -49.

A Bitcoin Buying Odyssey: Part 1

I heard that buying Bitcoin is pretty hard, but figured I could figure it out. I happen to cover blockchain, and am up to speed on some of the newest blockchain and cryptocurrency happenings, so it should be a piece of cake for me.

Boy was I wrong.

In only a few minutes, I realized how hard securely purchasing bitcoin is. Hours turned into days, and things got more unbelievable. I was shocked with how difficult it is to securely transfer fiat currency to Bitcoin. I knew I could’ve gone the soft wallet route, like storing my coins on an exchange, but I tried to avoid that at all costs. Online exchanges  lack the security I want for a substantial Bitcoin purchase. Unfortunately, I found linking an offline Bitcoin wallet to an exchange a confusing and near impossible task.

I learned about paper wallets, journeyed to the bitcoin subreddit, and had my phone number compromised on a Bitcoin exchange.

Sounds like a typical bitcoin experience to me.

Sunday

11:00 am: Off to the local mall to buy a USB stick to hold my bitcoin wallet. I’ve read and written way too much about online accounts getting hacked, so I want to avoid having my bitcoins online as much as possible. The plan is to hold my bitcoin wallet on my USB drive, taking my wallet “offline”. It’s the equivalent of a safety deposit box.

11:15 am: Back at my desk. Apparently, I bought the wrong type of USB stick. I need to buy a special encrypted USB to execute my plan.

11:20 am: Looking up a guide on how to encrypt my cute little SanDisk storage stick. It takes only 15 easy steps, including taking out my computer battery and disconnecting from the internet.

11:30 am: The more I read, the more I frustrated I get. If I want to keep my wallet on my computer or regular USB drive, I need to download the ENTIRE bitcoin blockchain before any transaction, which can take DAYS.

11:40 am: I’m a journalist covering bitcoin and blockchain and am currently using a WikiHow article with cartoons as my guide.

11:45 am: Tradestreaming editor, Zack sees my plight and suggests getting a wallet from Ripple, the well known blockchain company. I’m hopeful. My hopes are immediately squashed when I’m greeted with this beauty.

retrieve_secret_key_-_ripple_trade

11:50 am: From an article on secure wallets: “To a new bitcoin user, this information might seem daunting. You might have heard of bitcoin losses due to hacks, malware, or perhaps simply human error. We suggest keeping most of your bitcoins in either paper or hardware wallets (or if you have the space, in Bitcoin Core). If you must keep bitcoins in online bitcoins in online or mobile wallets, spread them around in a few reputable websites as recommended above.”

12:15 pm: Just spent the past 25 minutes trying to figure out what a paper wallet is. Here are two answers to the question of “what is a paper wallet,” one is made up:

  1. A piece of paper folded into an origami envelope that holds bitcoins offline.
  2. A piece of paper with a QR code that serves as a bitcoin wallet or something like that.

Give up? Here’s a picture of a paper wallet.

front-back-sample-big_jpg__jpeg_image__880-x-591_pixels_

So, one of the most secure ways to hold bitcoins is on a PIECE OF PAPER? I’m starting to see why people are a little bearish on bitcoin moving mainstream.

12:25 pm: Zack, aka the King of Google, finds that mobile wallets are pretty secure. I’m tabling the mobile wallet to tomorrow, going back to the hardware route and watching a video about a Ledger-encrypted USB.

12:25:05 pm: Oh no, the video is narrated by a generic robotic sounding voice. Is this the blockchain communicating with me?

12:30 pm: Just finished the video. I was OK with entering a 4 digit pin every time I use the device. I was even cool with the 24 randomly generated words required for account recovery. But consulting with a DECODER RING for every transaction is a little ridiculous. I just want to buy Bitcoin!

how_to_use_your_ledger_wallet_nano__tutorial__-_youtube

12:40 pm: Bitcoin.org is my new guide. Still dreaming of using my USB stick.

12:42 pm: “Reddit has the answer.” –Zack Miller

12:45 pm: First post on  r/bitcoinwallet: Still don’t understand paper wallets. You and me both.

bitcoin_wallet

12:50 pm: Reddit does have the answer: We’re back to hardware. Consensus: Mobile wallets are OK, but if you have more money than you can afford to loose, use a paper or encrypted USB stick. So if I have money I can’t afford to loose, its safer for me to “store” my coins on a piece of paper than online. Good thing its not 2016.

1:00 pm: Done. Just went to Amazon and bought my own Ledger Nano S, the device without the decoder ring. Waiting for the Prime delivery to come now.

Monday

12:58 pm: So I decided to try and use a mobile wallet. For sure I’m not putting any money in a online marketplace, but I’ll give it a go on the mobile app for the full experience.

1:00 pm: App Downloaded. Don’t judge me for not updating my apps.

img_1905

1:13 pm: After writing down my 12 word recovery phrase, I now have a wallet with a QR code. Great. I don’t know what to do next. It’s confusing.

1:15 pm: There’s nothing on this app. Just send money and a QR code. Not sure what to do next, so back to bitcoin.org.

1:20 pm: Wallets don’t have an integration into an exchange, so after trying to avoid online exchanges for so long, I have to deal with Coinbase, the highest rated exchange.

1:22 pm: There goes open borders and free trade and all that fun.

coinbase_and_tradestreaming

1:24 pm: So I’ve given up on the mobile wallet. There is no seamless integration, no website it sends you to. The wallet creators assume that you are a bitcoin genius before you download the app. Maybe that’s why people aren’t buying.

Tuesday

4:04 pm: Plugging in my new Ledger s.

img_1914

4:12 pm: So I set my Ledger up — I have a 24 word backup and a pin. Now lets see what’s next.

4:15 pm: We’re back at square 1, and I see the issue with buying bitcoin. I have a wallet and it’s set up, but now what do I do? Do I go on to an exchange and buy bitcoin? Where do I send money to? If I send money to an online gateway, is that secured or do I risk a hack on my bank account? I’m very confused. Once you have Bitcoin, it seems pretty easy to move money around. But there is not good on-ramping to convert fiat currency into cryptocurrencies. This is a huge barrier to entry.

4:20 pm: Half of me is thinking it’s crazy that Bitcoin is at $700 a coin when it’s so difficult to buy. The other part of me says that if someone ever figures this out and is able to bring it to the general public, Bitcoin is going to go through the roof. Leaning towards the latter.

4:22 pm: I still can’t figure out how to deposit cash into an exchange. Some won’t let me trade because of my location, and some are soooooooooo sketchy.

4:29 pm: So I’m on this exchange called Kraken — looks pretty legit. You have to be verified in stages to put dollars into the account.

4:33 pm: So I’m verified, but I just found out that I need to be tier 3 verified in order to put USD into my account. Sounds good, I’ll work on that next week.

Saturday

7:00 pm: Just got an email that my mobile phone number was compromised four days after registering with Kraken.  I can’t even.

search_results_-_joshliggett_gmail_com_-_gmail

Its been a week, and I’m nowhere near close to finding a secure way to buy Bitcoin. I’m starting to realize that I’m going to have to put some money in an exchange, which does not make me a happy camper. Off to do more research on how secure credit card and bank account numbers are on cryptocurrency exchanges. I’m going to keep going on my quest, so stay tuned for part two.