Episode Transcript
Speaker 1 00:00:06 The contents of the T P R podcast and the opinions expressed therein are solely for informational purposes and do not constitute financial investment or legal advice. Welcome, you're watching the Tron policy report with us today. We have Michael Fri. Mike has extensive experience in navigating emerging government regulations. He's advised clients on regulatory compliance investigations and enforcement matters relating to digital assets and on investments and corporate and organizational structuring, governance and best practices.
Speaker 2 00:02:11 Mike's background in the cryptocurrency industry began at the Commodity Futures Trading Commission, or the cftc, where he bought one of the CFT C'S first enforcement actions involving cryptocurrency and was part of the team responsible for the CFT C'S Action against Tether in 2021. He also contributed to the CFT C'S final interpretive guidance on actual delivery for digital assets. Mike is highly experienced in litigation and has served as senior advisor and legal counsel to Mayor Lightfoot advising on legal policy and labor issues. Additionally, he served as the chair of the Public Policy and Regulatory Committee of the Global Digital Asset and Cryptocurrency Association in 2022. Mike is a highly skilled lawyer with a wealth of experience in navigating complex regulatory issues in the digital asset industry. All right. Well, Mike, thank you so much for being on the show with us today. Now, there's a lot happening in Illinois right now. Uh, Illinois has just proposed a bill known as Dara, uh, that could have some, some big impact on the industry there at Illinois, everything from the business enterprise level down to an individual level. So could you just take a moment and kind of give us an overview of Dara and what it's proposing?
Speaker 3 00:03:25 Sure. I'd be happy to do that. Uh, and thanks very much for having me. Uh, I'm excited to be here. Um, so I guess before I get into the particulars about Dara, I think it's important to just kind of step back and talk about what's going on here. A lot of states have noticed, obviously, that there's a major gap in, in regulation at the federal level. Uh, and there's not, there's, you know, there does not seem to be any significant progress for, you know, real policy making at the federal level. Um, certainly in Congress, uh, you know, all of the activity, um, at the federal level has really been essentially regulation, you know, by enforcement, um, or, um, you know, limited administrative actions that bodies like the CFT c the S e c and banking regulators can take. So, so there's really a void. Um, and some state regulators have, have tried to step in to fill that void.
Speaker 3 00:04:16 The first, you know, way early out of the gate was obviously New York with the BIT license regime, um, but in the last, I'd say six months or so, we're seeing a number of other states, uh, come in to try to do something similar. Um, and in some instances, you know, go further than what, uh, New York did in in Bit License, uh, New Jersey is, is an example of that. Um, Pennsylvania is a, is an, is an example of something that their efforts, that's, that's just starting there. And Illinois is another example as well. Um, so with that is background. I can give a little context about what Dara is trying to do and kind of where it's at. Would that be helpful?
Speaker 2 00:04:55 Yeah, absolutely.
Speaker 3 00:04:56 Um, so Dara stands for the Visual Assets Regulation Act, um, of, of Illinois. And it was, it's a bill that's been proposed by the banking regulator here in the state, uh, called I D F P R. And essentially, it, it's, in a lot of ways it's quite similar to, to, to the New York Bill Bit license, and it broadly defines something called digital assets business activity. Uh, and in order to conduct digital assets business activity in the state, you you need to have a, uh, a license from I V F P R and digital assets, uh, business activity is, is really defined, um, quite broadly. So, uh, it, it means exchanging, transferring, or storing a digital asset. It means engaging in digital asset administration, which we can get into. Um, and then there's a broad catchall that says any other business activity involving digital assets designated by, ruled by the department.
Speaker 3 00:05:53 So essentially, I D F P R would, would reserve authority to deem, you know, any other, um, any, any business activity it deems to be, um, important to be covered by the, the law. Um, and again, broadly speaking, if you're, if this were to pass, if you're engaging in digital asset business activity, then you need to get a license from, um, from the state regulator. Um, and you need to comply with all the various requirements. Everything from having a help line set up that a customer could call to capital requirements to insurance. Uh, it's a whole panoply of, uh, of regulation there. You kind
Speaker 2 00:06:32 Of touched on, um, some of the, the compliance that people will have to meet in order to get this. Um, and it seems like a lot I was reading through the bill and there's just, it, it, it makes it seem almost like impossible or just very hard. Very hard.
Speaker 3 00:06:49 Yeah. You know, I think it, first of all, I, I'll, I'll say that it is well intentioned. You know, the, the regulators here in Illinois are, are, you know, they're seeing some of these, you know, crypto related frauds and, and, uh, and, and big bankruptcies that are happening, especially in the CFI world. Um, and there's a real impetus to protect, you know, Illinois customers. Um, you know, since this was announced a few months ago, there, there have been a lot of discussions with the regulator and, you know, in the legislature about, you know, what are we really trying to do here? Is this the smartest way to, to go about it? And one of the big biggest points, um, that's been discussed here is kind of like the difference between how do we regulate defi versus how do we regulate, you know, centralized financial institu, you know, centralized financial institutions like exchanges.
Speaker 3 00:07:36 Um, you know, if you read the bill, a lot of what is written here makes some sense, I would say, for, you know, trust companies or centralized exchanges that are holding customer funds. You know, things like capital requirements and disclosures, uh, conflicts, disclosures, and, um, you know, insurance requirements. You know, that, that makes some sense for an entity like a Coinbase, um, which is not regulated really at the federal level, um, in the way the bank would be, um, or at the state level. But it makes a lot less sense when you're talking about, you know, um, a decentralized, you know, finance protocol. Or if you're talking about a startup launched by, you know, some students at University of Illinois who are building something out of their dorm room. Um, and there's been real concerns about, um, you know, is this overroad, you know, what are we trying to sweep in? And are we painting all of crypto, all of web three with the same broad brush?
Speaker 4 00:08:32 It's good. I love that you differentiated between those, because I think, I think, and there's confusion right across the landscape when it comes to whether it's central banking concepts, uh, the digital currencies there, stable coins, the, the differences in the exchange versus decentralized elements. And I mean, what do you see as, as far as how Illinois is going? Kinda two part question here. Like, the implementation of a bill like this, it's gonna affect individuals, it's gonna affect enterprise. What do you see the challenges, right, of implementing something like this? Uh, is it welcoming of crypto? Is it welcoming of blockchain tech and innovation? Like, like what, what do you see some of the challenges, uh, to be or forecast those to be? When you talk about in implementing this?
Speaker 3 00:09:20 Yeah. Implementation, it would, would be very challenging were this bill to pass and, and I'll just say, um, you know, it was announced a few months ago, uh, very quickly, uh, and without much debate, it, it's, it's successfully passed the Illinois House and it's now in the Illinois Senate. Um, it's been assigned to a committee. There was a hearing on the bill on Wednesday, um, where frankly a lot of these discussions, these concerns that you and I are talking about now, were, were, were raised. So it's really unclear what's gonna happen with the bill. Um, the, my understanding is that the, uh, you know, I'm not a Springfield insider like some of my colleagues are, but my, my understanding is practically the deadline for the bill to move out of the Senate and get to the governor's desk is later this week is the 19th.
Speaker 3 00:10:08 And if it doesn't move this time, then, you know, I D F P R could, could try again. Um, you know, in the Vito session or, or next, next session, which frankly is, is a, is a very real possibility. So even if it doesn't pass this time, I think there's a, there's a good chance we'll need to deal with it again. Um, implementation would be, would be very, very challenging. Um, you know, the Illinois banking regulator is a, is a small, is a small regulator. We're talking about, you know, hundreds if not thousands of, of applicants that would in theory need to be licensed here. You know, there, there is a, um, transition period, um, specified in the bill, so it wouldn't go into effect overnight. Um, but you know, the way it's written now, if the, if the scope doesn't change, then we're talking about, you know, pretty much every business entity in Illinois that touches crypto. And one of the ways I've described what would need to come in and, and get licensed, um, you know, there, there's also in terms of, of, um, uh, implementation there, there's a lot left to rule the rule making. Um, there's a lot of authority delegated to the state regulator to write rules governing the particulars of, of what would be regulated and, and how it would be regulated. Um, so e expect if this were to pass a long process, um, of, of rulemaking as well before things really get firmed up.
Speaker 2 00:11:30 Yeah. So we were just kind of talking about, uh, other states that have started to sort of outline their own regulatory framework. Um, I think a good question for that is what's, what do you think has sort of led to states stepping up to begin to, to promote their own legislation and their own, their own regulations here? What, what sort of things have led to this being the case? And is this something that you see as a continuing trend?
Speaker 3 00:12:00 I, I do, you know, and, and again, you know, I think, um, lawmakers in, in states, you know, in large states, uh, ha you know, feel pressure, I think to make sure their, their customers are protected and, and to make sure that, um, some of these, you know, really bad, um, um, you know, collapses like we saw a few months ago with ftx, um, aren't gonna directly impact their, their, their residents. Um, you know, and I think, I think another, you know, one of the things that's motivating all this is that there's really not a, a clear regulator at the federal level who's, who's responsible for, um, for all aspects of, you know, kind of the crypto market. Um, there's no banking regulator you can point to. I mean, FTX obviously was a, was a watershed moment. Um, and a lot of the fallout we're seeing now are, are, are regulators kind of taking a look at what could have gone differently.
Speaker 3 00:12:55 Um, and you know, there, there's no cent, there's no one regulator at the federal level who's responsible for, uh, centralized exchanges. Um, and there's no one regulator responsible for, for crypto. Um, and so part of the, part of the narrative we've seen has been making sure people understand that actually there are a lot of, um, three letter agencies, <laugh> or four letter agencies that are already involved in policing the markets. Um, one, one little vignette here in Illinois, um, when, when lawmakers, you know, when the proponents of this bill were, were in Springfield talking about why it was necessary that, you know, they pointed to this fraud that occurred in Pilsen in Chicago by a company called Crypto fx. Um, Pilsen is a heavily Latino neighborhood, um, here in Chicago. And Crypto FX was essentially operating a, a fraud, a a crypto fraud. Um, and, you know, they were taking folks money and not doing anything with it, stealing it, essentially.
Speaker 3 00:13:57 Um, and one of the reasons why, um, this bill was, was being brought forward was, you know, hey, the need to protect, you know, residents in Pilsen and elsewhere in EL in Illinois. Um, but you know, what was interesting about an argument like that is like, look what happened to these guys? You know, the, the crypto effects, uh, team was all charged by the S E C, um, you know, there are multiple investigations against them. Um, you know, their business has been shut down. So, you know, a question that was raised is like, well, is this working? You know, maybe there's enough, uh, regulation, maybe there's enough, you know, a authority al already in place. Um, and when you look at the, you know, how active the s e c, the CFT c doj, FinCEN, you know, has been in the space, um, you know, you, you start to ask, you know, why does a, a specific bill like this that, you know, licenses this activity, um, you know, why, why is that necessary?
Speaker 4 00:14:49 Yeah, it's important. And I mean, I, I think, and I think in what you do in the line of work that you do, obviously you're constantly thinking about both sides, like the individual, the, the, the enterprise side as well. I mean, like how, what's, what's that balance, right? How do regulators strike the balance between protecting the individual like those, those residents there and Pilsen, you know, how did, how does it strike the balance between that versus really welcoming the innovation? Because, you know, like, I mean, look at, look at one of the major CAD campaigns out right now that's, that's pushing back and saying, we've got an outdated financial system. It's old, and it's, you know, all that stuff. Like what's that balance between, we know we need some innovation, but we also really h h how do you inform and encourage regulators to think about that?
Speaker 3 00:15:37 Yeah, I, I, I think there, there is a real balance, you know? Um, and, and to me, like I'm, I'm a former, uh, federal financial regulator myself. I, I, I worked for years at the CFTC in the division of enforcement, but I'm, so, I'm, I'm certainly pro-regulation if it's smart and common sense and is effective. Um, but, you know, I'm also deep into crypto and all, all of my clients pretty much are in web three and digital assets in some way, shape, or form. So, so for, and I, and I see the real value of, of the technology. And unlike some in Washington, I mean, certainly I, I, I don't think it should be, you know, squashed out or regularly out of existence. So for, for me, there's a few principles that, you know, this is my personal opinion here, but there's a few principles that I think are, are salient.
Speaker 3 00:16:22 You know, fir first and foremost, you know, my, my my belief is that if you're operating a centralized financial institution where you are holding customer funds and you control customer funds, um, you are essentially operating something that looks very much like a bank, and I think you should be regulated. Um, some, you know, something like a bank or a, a, a financial intermediary like, um, a trust company or an ats. Um, you know, when you look at, um, what happened with, with Sam McMan Fried and, and ftx, that that really should not have happened. There should have been some kind of a prudential regulator making sure that that, you know, the customer funds were there and the principles of, you know, uh, you know, safety and soundness and security were being maintained, you know, just, just like a, um, uh, A D C O, you know, in, in the CFTC space or, you know, like a securities exchange in the security space.
Speaker 3 00:17:18 So, um, at the same time, I, I don't think that that same level of regulation or type of regulation makes sense when you're talking about the technology itself. So it's really, it's really distinguishing between centralized entities and the underlying technology. You know, there's no regulator that oversees, you know, uh, the code base that runs the email. Um, you know, there's, there's no regulator that actually, you know, polices the internet as a technology itself. Um, and I think that's right. I think that makes sense. So that's, I think principle one would be C5 versus Defi and treating them very differently. Um, and then principle number two is self-regulation. Um, you know, we've seen, uh, uh, there's a great history in this country and around the world of industry coming together to, to regulate itself. Um, you saw that in the security space, you know, with FINRA in the commodity space with, you know, the N F A.
Speaker 3 00:18:16 Um, and there's, you know, many, many decades of historical precedent, uh, around that and Web three and crypto, they've, we've been trying to, to, and there's, you know, there's a bunch of different, um, groups that have come together to stand up. Probably the biggest one, the one I'm involved in is called the Global bca, global Digital Asset and Cryptocurrency Association, which is, you know, essentially group of people coming together to say, we wanna be a self-regulatory organization for the space, um, and write rules and, you know, police ourselves. Um, so that would, I think that, I think a lot of, a lot of work can be done there, um, you know, with common sense, smart regulation driven by the industry. Um, and then, um, the, the third thing to keep in mind is what I touched on before is, you know, really broad anti-fraud, anti manipulation jurisdiction. So it's one thing, I think giving regulators the power to write rules to govern an exchange like Coinbase is, is one thing. Um, and I think we should be relatively narrow around that, but, you know, giving DOJ S E C C F T C the authority to, to police fraud, um, and come in hard when people are harmed, I think is super important. And we, we have that today. So those are my big three. Those are my big three.
Speaker 2 00:19:30 That's good. Yeah. And I, I think, you know, you touched on something, we've, we've dropped FTX now twice, and, and I think that it's, it's significant, right? Because as soon as we saw that sort of the wake of that was a more, um, reactive versus proactive approach, uh, because something had to be done at that point. Um, and so I, but I see this shift happening now where we're moving more towards proactive versus reactive, which is really, it's positive for the indu industry overall, I think.
Speaker 3 00:20:05 I hope so. You know, I, and like I, you know, I think, you know, uh, bear markets are for builders. I hope the same is true when it comes to regulation that now is a good time for us to sit down and, and think through, um, common sense, you know, comprehensive regulation. But to me, like that really starts with Congress. And the, the conversations have not been very productive, um, from what I can tell <laugh> at the federal level. Uh, and it's unfortunate, you know, um, uh, many people know this, but Sam Bain fried in a lot of ways was sort of the, the standard bearer for, for smart regulation at the federal level. You know, he had a, a bill that he was shopping around Washington and he had a, a number of sponsors, and it made sense. It would've covered centralized exchanges in the way that I, that I've discussed, and they would've covered, covered stablecoin and, and a lot of other areas where there's uncertainty.
Speaker 3 00:20:54 And I think rightly so, a lot of lawmakers in Washington felt very, very badly burned, um, about what, what happened, um, and pulled back away from, from that proposal in particular. Um, another example is, uh, FTX had this innovative ftx, us or US arm had this really innovative idea where they were proposing to issue derivatives directly to US customers without going through an intermediary. Um, and they were arguably allowed to do this under, um, uh, A D C O license that they had acquired. Um, and they were seeking approval from the cftc. And, you know, this was pre collapse, obviously, and the, the, it was a pretty radical proposal. And at the time, the CFT C'S position was, okay, let's talk about this. And they, and they had a number of round tables, you may remember those. There was a congressional hearing about it, and the answer wasn't no off the bat, you know, people were, the CFTC was taking it seriously. Um, and then FTX blew up and, you know, I don't know what, what happened behind closed doors over in Washington, but boy, I, I bet you they're very glad that they didn't move forward with, with that <laugh> with that, uh, proposal. And I think rightly so now there's kind of like this, this fear that, you know, any engagement with the crypto industry is gonna, is gonna backfire, um, on lawmakers and regulators. So we, we really need to, to overcome that dynamic and, and do something that makes sense.
Speaker 4 00:22:25 Well, I I know we're getting into word wrapping up here, but I, I think you just touched on something that's super important and, and, and that leads to, I think, why the states are taking action, right? And, and, and, but it is, so, it is such a walk on eggshells kind of thing, right? I mean, it's such a, whatever great metaphor you wanna throw in there, it's such a, it's such a, um, sensitive moment because I think you've got the commerce side of what states wanna do, and they want to welcome business, and they want to welcome innovation and they want, and then you've got the, but oh, no, what if all of a sudden, right? And I mean, so how, how, how can states and, well, first, which states do you know about cause of your network and cause of what's going on with the global dca? Like, which, which states do you know, that are really trying to move forward in this? Um, just would love to hear a quick highlight on that, but then like how, how, how do they approach that Tinder, that that fine line right in, in going about this?
Speaker 3 00:23:27 Yeah, so there, there was a, a very concerted effort in New Jersey, uh, a couple months ago to, to try to do something very similar to the Bit license regime. And I think, uh, I, I, I'm not fully up to date on what's going on there, but I think it's fair to say it was essentially stopped, um, by, you know, proponents of in the cryptocurrency, you know, industry because it, it, it didn't make a lot of sense for a lot of the same reasons, you know, we've talked about it today. Um, I know Pennsylvania is very early, um, on doing something similar. California had an effort that started and then stopped, was stopped by the governor. Um, and, uh, uh, in from, I've, I've heard some discussions that, you know, these large states are, you know, they, they're, they're talking, um, you know, amongst themselves to try to come out with some kind of a coordinated approach.
Speaker 3 00:24:17 Um, which I, I welcome if there's gonna be state regulation, it should be, it should be coordinated. Um, I think a, a big question is like, has the bit license regime been successful? Um, you know, like would it have prevented the ftx, uh, uh, you know, it, um, fallout or collapsed? I, I, I don't think so. Um, if you look at who's been licensed in New York, it's very few licenses have actually been issued and, and you know, they're all from the biggest institutions that can afford to go through that, that process. Um, so I guess it depends what metric you, you judge it on. Um, but you know, you, you have to ask, you know, for, for many of my clients, New York is a big black hole. It's a no go, it's a no-go zone. Um, and, you know, I guess query whether that's the, a feature or a bug, you know, <laugh>, is that, what, is that what the intent was or not?
Speaker 3 00:25:12 You know, the, in Illinois, um, there's a thriving startup community in Chicago, um, in web three. Um, there's a lot of founders here. Um, a lot of dc it's kind of, you know, um, underappreciated, uh, as one of the capitals in my view of, um, uh, you know, digital assets here, here in the US and the governor last year, you know, ma made some announcements about, um, his support for the industry. And I, I, I do think that's still there, but you're right, Jason, there, there's a, um, a a balance trying to be walked between protecting investors, protecting residents, and and welcoming, um, businesses. And in my view, the way to do that is to, is to regulate centralized players that hold people's money and give free reign to the development of the technology itself. Well,
Speaker 2 00:25:59 I think this has been a really insightful conversation today. Um, thank you so much for your time. I appreciate you being here with us and telling us about this. Um, now we will learn more about Zara on May 19th. Yeah,
Speaker 3 00:26:14 Yeah, that's right. I think we'll know more, um, we'll know whether or not something changes and, and it moves, um, by, by the May, by May 19th. Um, and, uh, yeah, and we'll, we'll see, you know, there's also the opportunity for there to be changes. It's certainly developing. It's, it's a, uh, kind of a fluid situation. Um, uh, it, the, the regulator has been pretty responsive, um, to, to the concerns of the industry. Um, you know, for example, recently they, they amended it to exclude, um, something that is, you know, purely the development of software. So the language says, um, it's business activity does not include the development dissemination of software in and of itself. So, again, that, that's a step, I think, in the right direction to acknowledging the difference between Defi and cfi. Um, but so, you know, you know, it's very fluid and, and changing. But if you're, if you're in Illinois, this is definitely something you should, you should pay attention to if your business is in Illinois or if you're touching Illinois, uh, customers.
Speaker 2 00:27:17 Well, thank you so much for being here today. We might have to have you back on to talk more about this, uh, when, when we know more about this, but
Speaker 3 00:27:24 <laugh>.
