This is a hell of a week for news about venture capital, which is of course joined at the hip to fintech. Sequoia Capital, the storied VC firm where I worked for a time, announced that it will pool all of its investments into a single fund. Instead of creating funds that last seven or ten years and then close out, the limited partner investors will be able to cash out more or less whenever they want. Sequoia is also registering as an investment advisor, which will remove some restrictions on how it can invest.
Perhaps predictably, FIN sees this announcement very much in line with a two-part series we are producing for the Observer about the death and future of venture capital; part I was published (before Sequoia’s bombshell) on October 14 and part II will publish in a day or so.
Then on Saturday a front-page New York Times story detailed a high-octane lobbying effort by Sequoia’s neighbor Andreessen Horowitz to shape the way that cryptocurrency—in which A16z is heavily invested—is regulated. The Times story quotes a law professor saying “This is a classic case of asking the fox to design the henhouse.”
While the specter of manipulative Sand Hill Road titans rewriting federal regulations to benefit their portfolios is a great and important premise for a story, the Times article was light on the mechanics of how A16z, beyond hiring influential people, is going to accomplish this. The most detail that readers are offered is:
Certain crypto start-ups that A16Z is funding are being organized around a new type of entity called a decentralized autonomous organization, or DAO, which would be exempt from the act under A16Z’s plan.
This exemption is warranted, A16Z argues, because DAOs are supposedly run by the community of crypto users rather than for-profit executives. But the financial backers of these platforms still stand to make considerable profits because the founders of the crypto start-ups often own a sizable share of the special crypto tokens that can, in some cases, grant voting power to help govern these platforms.
The A16Z proposal would also limit the ability of the Consumer Financial Protection Bureau to regulate DAOs beyond requiring certain disclosures. It instead proposes that the federal government consider relying on an industry-created “self-regulatory organization” to define and enforce how consumers are treated. And it would give preferential tax treatment to DAOs, limiting information they have to turn over to the Internal Revenue Service and making so-called member dues that they collect tax exempt.
That all sounds scary from a public policy point of view, but the reality is more complicated. A16z provides two fundamental rationales for its proposal, both of which contain at least half a truth. The first is basically: crypto and DAOs can be built pretty much anywhere, and if US regulation makes it difficult or impossible to do here, the industry will take its wealth elsewhere. That may not be a good enough reason to allow the industry to regulate itself, but it’s hardly a crazy assertion.
The second rationale is that current regulations are a confounding hodgepodge of overlapping jurisdictions that could benefit by the clarity that A16z so generously supplies. The section of the proposal where this is discussed is about as funny as crypto lawyers get:
For corporate law purposes, when two or more persons engage in an endeavor, the imputed structure is that of a general partnership or an unincorporated association….However, while DAOs may be analogous to partnerships, they are not partnerships. For instance, DAOs can be comprised of hundreds of thousands of pseudo-anonymous persons and are not necessarily operated with for-profit intent. Similarly, they may be analogous to corporations, and yet are not corporations; they may be analogous to joint tenancies, and yet are not joint tenancies; and they may be analogous to mutual agencies, and yet are not mutual agencies.
Again, one need not agree with the A16z prescription to acknowledge that the diagnosis is fairly unimpeachable.
Yet while crypto lawyers are lavishly paid to argue the appropriateness or inappropriateness of analogies, there is in fact a concrete history of how the federal government treats DAOs. It’s understandable why A16z lawyers don’t mention this history, but its absence is the biggest flaw in the Times’ generally enlightening story. Way back in 2017, the Securities and Exchange Commission (SEC) issued a full report regarding an unincorporated organization called, conveniently, The DAO. The DAO was built on the Ethereum blockchain and raised $150 million in token sales from more than 11,000 investors. Before it could do anything with the money, however, a group or individual hacked The DAO’s code and diverted about a third of the money.
The SEC investigated the incident, and while no fines or penalties were assessed, the conclusion was about as unambiguous as these things get.
Based on the investigation, and under the facts presented, the Commission has determined that DAO Tokens are securities under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”). The Commission deems it appropriate and in the public interest to issue this report of investigation (“Report”) pursuant to Section 21(a) of the Exchange Act to advise those who would use a Decentralized Autonomous Organization (“DAO Entity”), or other distributed ledger or blockchain-enabled means for capital raising, to take appropriate steps to ensure compliance with the U.S. federal securities laws.
There might be a little wiggle room there for some DAOs to get exemptions, but as a category the report was fairly clear. (Shortly after the SEC report was released, Canadian regulators issued a very similar guideline.)
And so, to come back to the Times story, the article’s influence scenario is that the (for now!) Democratic-controlled Congress—you know, with Maxine Waters as chair of the House Financial Services Committee, which AOC also sits on—is going to change the tax code to weaken a Trump-era SEC decision, in order to help out a Facebook-identified VC firm (which technically isn’t a VC firm anymore) because it has hired some friends of Joe Biden. This, as a political prediction, is not how anyone FIN knows—especially not in Silicon Valley!—thinks things are generally headed.
It could happen, theoretically, but it would require a supine response from current SEC chair Gary Gensler (who also is not mentioned in the Times story). The idea that Gensler is keen to overturn the SEC’s 2017 DAO ruling is far-fetched. Indeed, in an order and $10 million fine issued this August against Poloniex, Gensler’s SEC essentially said “Ever since we issued the DAO Report, you should have known that what you were doing was illegal.” Such track records are very hard and rather irresponsible to reverse, even if some charismatic VCs and their lobbyists would like them to be. If A16z genuinely wants to be helpful and productive on this front, it should offer a legal framework around DAO tokens as securities. Or maybe it’s waiting for a Republican Congress, but that doesn’t take care of the Biden/Gensler barrier any time soon.
This piece originally appeared in FIN, James Ledbetter’s fintech newsletter. Ledbetter is Chief Content Officer of Clarim Media, which owns Techonomy.