Hi, it's Colton. I wrangle code and compliance at Hedgehog, the crypto robo-advisor that makes it easy to maintain a diversified, balanced investment portfolio of digital assets.

New Rules

Speaking of compliance — the most thrilling of my specialties 😉 — last week we discussed what makes a security a security, one of the central issues in the debate about crypto regulation. I received a thoughtful reader response:

To answer your question, most cryptos (by number) are securities, because they pass the Howey test. Only the large cap ones (beyond a certain size) could be commodities, or those which are specifically marketed only for their utility. But in terms of regulations, the traditional rule set is unlikely to work very well.

I believe the best approach is to have a separate system for cryptocurrency projects.

1. Participation is based on a proof of knowledge, meaning the person knows about the various types of scams and how to protect digital assets. They could complete their testing at any of the large exchanges and it should carry over between them.

2. Cryptocurrency asset platforms need to undergo peer reviews to ensure security — keys are stored properly offline and held by multiple operators who have autonomy to reject unethical or criminal transfers. And a review to ensure any custodied assets are fully backed. A rotation of validators should be used to avoid any bias.

3. There should be some form of insurance fund set up to assist when things go wrong. I believe that a structure governed more by an evolving case law than some fine print contract managed by a for-profit third party would better serve the public interest. A multi-sig held by a cross-section of industry participants could handle the disbursements. This kind of structure could flexibly handle all kinds of situations.

Sounds pretty sensible (but I am not a lawyer, and as a general principle you shouldn't take legal advice from strangers on the internet without consulting one). Now, would this function well in practice? That is always hard to answer before you give things a try.

Gall's Law states, "A complex system that works is invariably found to have evolved from a simple system that worked. A complex system designed from scratch never works and cannot be patched up to make it work. You have to start over with a working simple system." (Side note, "How Complex Systems Fail" is a great short read.)

I don't intend to denigrate the ideas above, far from it. Rather, I want to point out that trial and error is how we discover which plans are useful, versus the ones that sound nice but prove to be impractical (or even harmful). Often there are many ways to implement a concept, but not all are effective. If we don't listen to new ideas, we can't learn anything!

Permissionless experimentation is how the current crypto landscape emerged — full of dysfunction, sure, but also phenomenal tools that only existed in sci-fi 20 years ago. Bold inventions, iterative tinkering, and freewheeling competition are crypto's sources of strength. "You don't know until you try" could be the industry's motto.

The huge risk of misapplied regulations is cutting off this creativity and locking in a suboptimal setup. It's not that I don't think there should be regulation at all. Realistically — empirically, even — the cypherpunk dream of anarcho-finance can only ever exist on the fringes. To the extent that crypto becomes more accessible and meshes with the mainstream, it will be overseen and modulated by government authorities.

So here's hoping we can muddle through to an equilibrium that serves all stakeholders. Yes, I said stakeholders; yes, I am a nerd. See, I just used a semicolon.

Quick Hits

An interesting ETH technology tidbit from The Block's Data & Insights newsletter (which does not appear to have a public archive, but you can sign up for it here):

Optimistic and zero-knowledge rollups publish their data on-chain differently.

Optimistic rollups publish batches of transactions in the calldata on the Ethereum mainnet, but you have to wait for a dispute period to pass to ensure the sequencer is not publishing invalid transactions before withdrawing.

ZK-rollups require a validity proof to be posted on-chain, much larger than the data requirements of ORs. This, in theory, means the amount of gas per published batch is higher, but the proof additionally removes the need for the dispute period.

Three links for your reading pleasure:

Lastly, back to regulation… "Coin Center made available a communications protocol that can effectuate trades of securities in a public comment letter to the SEC. We will not be registering as a securities exchange," says spokesman Neeraj Agrawal.

The PDF is available in full on Coin Center's website: "Comments to the Securities Exchange Commission on Amendments Regarding the Definition of 'Exchange' and Alternative Trading Systems." That sure is a mouthful.


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Keep hedging,
— Colton

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