@xing asked me a question in another thread regarding the relationship between the Pangolin platform (currently decentralised) and Ava Labs so I think it’s worth exploring some of the issues related to that because they are not insigificant and will have long term implications for Pangolin that aren’t necessarily apparent to most people.
Last week I held a small presentation for some interested devs to go over the regulatory issues that I think Pangolin will face and how these regulatory challenges are affected by the involvement of Ava Labs staff, both in terms of their contributing code and technical support the the broader support and promotion offered by Ava Labs execs,
Before I dig in, I should say that this isn’t intended as legal or investment advice to anyone - it’s just my opinion having worked as a lawyer in the tech and crypto space for a long time. If you think this affects you or your investment, please seek out specialist legal, tax and accounting advice in your home country.
There are 2 main trends happening in this space that are relevant here:
- Greater pressure for capital formation and capital raising to be conducted in a regulated fashion in order to protect retail investors; and
- Increasing scrutiny into the ways crypto and decentralised projects enable money laundering, tax avoidance and terrorist financing.
Both 1 and 2 become a more serious concern when established businesses get tangled up with the platform in any way. The reason for the increasing risk is simple: it gives regulators a target.
- Securities Laws
There’s at least one good reason why Ava Labs didn’t market AVAX to the US market during the initial sale - they would have been justifiably concerned about having to register the sales under the Securities Act. Kik, Telegram, Ripple and dozens of other projects have been prosecuted for not registering token sales. There might be other reasons as well, but I’m pretty sure that’s a big one. Registration isn’t a bad thing per se but it’s costly and requires a prospectus as well as ongoing monitoring, reporting and compliance obligations. The recent explosion of SPACs in the US is part of this trend to side-step compliance because it’s a pain and costly too. And that’s before I get to the increased exposure to securities fraud class actions that usually follow many successful start-ups who go public.
Some of you might say - but Pablo, PNG isn’t sold by Ava Labs so why worry? There’s not much clarity in the space regarding governance tokens and DEXs and I don’t intend to conduct a deep dive into securities laws around the world but when we consider that (i) PNG is being purchased as an investment, (ii) there are elements of horizontal and vertical commonality between investors, devs and Ava Labs (iii) PNG relies today on the involvement of Ava Labs and (iv) Ava Labs still appears to hold the keys to Treasury, PNG starts moving into investment contract territory.
Moreover, the greater the role played by Ava Labs staff and the greater the reliance the community has on that support, the greater the risk PNG would be viewed as a securities offering in the US and other jurisdictions. Again, that’s not absolutely certain and fixed but the risk is not simply theoretical. We are heading in that direction and we, the community, need to address it.
Some of you have probably seen the reporting of the Financial Action Task Force (FATF) attempting to extend VASP (Virtual Asset Service Provider) obligations to DEXs and DApps. I won’t analyse it completely here other than to say that the types of measures the FATF recommends platforms consider include the following:
How they might limit volume or size of transactions;
Developing KYC programs;
Considering how organizational and operational complexity enables money laundering and terror financing;
Where the VASP is registered and whether they are operating in a cooperative jurisdiction (instead of small tax havens with minimal oversight);
Whether VASP implements the ‘travel rule’ or not (i.e. being able to keep records of senders and receivers of transactions;
The specific types of tokens and services that a platform offers or plans to offer and any unique features such as embedded mixers or tumblers;
VASPs’ interaction with smart contracts that may be used to conduct transactions.
The FATF recommendations in relation to DEXs and DApps are only draft at this stage and not yet law in any country but they indicate what member nations anticipate the regulatory environment to look like in the near future (i.e. 12-18 months). Over 200 countries and jurisdictions are parties to the recommendations
We already know that it will be extremely difficult to regulate DEXs. But that won’t stop countries trying. I believe that most, if not all, DEXs that want to be recognised by institutional investors will need to get their houses in order. That could take many forms - industry self-regulation or codes of conduct or even a formal association of DEXs banding together to shape policy and increase awareness and recognition.
However, in the meantime we have a more pressing and difficult question: what role can Ava Labs play in the ongoing development and growth of Pangolin that doesn’t expose them and/or Pangolin to regulatory consequences down the track? On a very basic level, I think that means solving the ownership of the Treasury keys. It also means that we need better rules of engagement with Ava Labs staff.
If that’s not acceptable, Ava Labs will probably end up being viewed as “owners” of the Platform along with the consequences that flow from that. I’m sure no one wants to see that either.
Regulations are coming so there’s no point sticking our heads in the sand. I am convinced that the better approach is to prepare for the coming regulatory environment as we enter widespread adoption. Not only is this a prudent business move but it provides Pangolin an important market differentiator and a significant competitive advantage.