Derek Edward Schloss is the Director of Strategy for Security Token Academy. In addition to his role at Security Token Academy, he is also an Oregon Attorney, having earned both his JD (2014) and MBA (2014) from the University of Oregon. His professional experience includes Co-Founder/CEO of a national apparel company, former Instructor of Marketing at the University of Oregon, and VC Fund Analyst. Derek received his Bachelor of Arts in Creative Writing from the University of Arizona (2008).
Hey everybody. Welcome to a very special edition of Security Token Academy, the 2020 pandemic edition. We are recording from our makeshift home studios scattered around the city, around the country, around the world. Today, I’m going to be speaking with a very special guest. His name is Derek Schloss. He’s the director of strategy for Security Token Academy. Welcome Derek.
Thank you, Adam. I’m glad we could do this. This is, I think this is going to be a fun addition.
Yeah, it’s nice. I think, with everybody cooped up inside, where the stay at home orders to flatten the curve for this pandemic. Maybe we can give people a chance to catch up on a little bit of the learning they’ve been putting off.
And we can enlighten some people about what they can understand about fractionalized securities and other good stuff.
Exactly. Let’s do it.
Okay. So Derek, you are an expert in ways that I can only hope to be. So, I’m excited to be able to talk to you about some of the things you’ve been writing about and that I think maybe some people have been following the stuff that you’re writing. And maybe they’re following your latest, but let’s dive into it a little more deeply. Why actually did you decide to write, it’s something called security tokens and the formatting revolution?
Yeah, no, that’s a great question. So Adam, well first we’ll say, we’re experts in different areas. And so, it’s always fun chatting with you because I get insight on things that I’m just not quite seeing. So, it’s fun to put our two heads together. Security tokens in the formatting revolution. So, I’ve been in this space for a couple of years now and generally, when I try to explain the benefits that will accrue to security tokens and blockchain based securities. It’s usually the two distinct groups of people. The first is folks who really understand the value proposition of digital assets that are bearer, that are fixed supply, things like Bitcoin. And then the other group are typically attorneys or traditional service professionals or financial industry vets. Who just don’t quite understand why to use blockchains for something like contracts and security token insecurities.
And so, this piece was really written... It was kind of born out of a number of these conversations over the last few years. Really trying to address both of those different camps and kind of position this idea of taking securities and putting them on trustless ledgers, as a formatting revolution. That’s basically 3000 years in the making. That was the approach that I took with piece.
I like that. A lot of people wouldn’t say 3000 years. I can’t wait for you to break that apart.
More years. Many years in the making.
So, before we get to the 3000 years that we’ve been waiting for this. So, you kind of lay out that there’s two layers, right? There’s this legal layer, there’s the formatting layer. So, you mentioned a little bit that there’s lawyers on the one side, but why are these important? How do they work together and what’s the difference?
Yeah, no. So, it’s great. So, the way that I like to think about this and I think, a lot of the misunderstanding or at least, struggling to understand the true value prop of what’s going on here. I think it’s helpful, as a heuristic organize these ideas into buckets. And so, the way that I did that was say, “Okay, here we’re going to have what’s called the legal layer. We’re going to put... As it relates to securities and contracts, we’re going to put things like our laws. So, the Securities Act of 33, the Exchange Act of 34. We’re also going to put our arbiters, our judges, our human decision makers and the decisions that they come to, as a result of those laws.” So starry decisis, we’re going to put that in the legal layer.
We’re also going to, kind of, put the principles of why we have these laws to begin with. So, investor protection, to protect contracting parties. And to facilitate efficient value exchange. We’re going to put that in the legal layer. So, there’s this mix of rules and regulations and principles and law making and decision making with judges. We’re going to group that into the legal layer. And the formatting layer is totally, totally different. The formatting layer only has one job. And the job for the formatting layer, that I argue, is over the course of history, the formatting layer is really meant to find optimal formats, by which to promote the legal layers value proposition.
So, for contracts and securities, the formatting layer has always yearned for formats that further investor protection or further the protection of contracting parties. Or it helps facilitate the efficient exchange of value. And so, that’s where I see these two layers intersecting. You’ve got the legal layer with all the rules and the rights and the regulations and the formatting layer, which is really meant to find optimal formats for that. And we can trace kind of those benefits over the course of history.
Okay. So now, we’re talking about the course of history. I like it. Hit us with this 3000 year idea. So, how have these two things been in existence even for, well, let alone the last 10 years. How about 3000 years?
Yeah, it’s true. So, you definitely have to zoom out a little bit and think about things a little bit more abstractly. And so, that’s kind of what I tried to do with this. But the idea is that, for as long as we’ve had rule of law, we’ve really tried to package it into better and better formats. And so, you look back to the first format for contractual agreements and it was the oral format. Oral format was great, right? So, you think about in the Roman Republic, they had this thing called Stipulatio. And this is, essentially, a format that allowed two contracting parties, that could orally agree through question and answer. And there was legal protections through that contract that they were able to form. They didn’t need to write it down. And it was a great way to take some of the principles of the legal layer and package it into a format, that was really easily to ease... Further the economy, further participation in economy.
The oral format though, it has its limitations. It’s not great at evidencing that the agreement took place. It’s also not great at evidencing what those terms are. And so, the next logical format, was the written format. And so, you’ve started looking back through history. If you look back through history, you can kind of see this play out. But we started finding these different features through written formats that could help further the legal layer. So, it started with durability. And so, the codes of Ur-Nammu, where these codes, this is like 2000 BC, is very...
And so, it was written on clay tablets and it’s great because it’s durable. We can go to a museum today and still see those today. The next kind of benefit from the written format was, the signature authentication. So, in 1200, things like parchment and the wax seal. And the wax seal was awesome because it could prove that, I as a party to this contract, intended to be bound to this agreement. And it was great in evidencing my participation in a contract and it also prevented fraud.
And then, if you keep going further through history. Later on, there’s just this idea of distribution. So, with the Gutenberg’s printing press. And later on the paper machine, in the 1700. These ideas really helped proliferate the written format in ways that we just couldn’t before. And so, this idea is, we go through history. These laws started taking different forms, based on finding more optimal formats to further those two goals that I described early on, which was protection and furthering value exchange. And we get to today where everything is moved from paper to electronic.
Yeah. So, I was going to say this, I love... First of all, what’s the over-under on number of months before a startup is named Ur-Nammu, right?
Man, probably 24 hours after this is live, Adam.
You know it’s happening. Okay. So, we’ve gone from Ur-Nammu, now to 2020. What does the current layer look like for securities, contracts, let’s say in the US, what are some of the problems with it? What’s happening?
Yeah, great question.
You mentioned digital, I assume that’s…
Yep. Yeah. So, in the 70s, there was this massive push and this was really as a result of personal computing and corporate computing. Where we were able to start taking the paper contracts that we made, the paper securities and have them live on as ones and zeros on electronic and digital databases. And so, that’s what our securities and our contracting environment looks like today. If you look at our public markets, our public securities live on databases. That are kind of centrally run by the DTCC and the intermediaries they are in. And our private markets, they also live on ones and zeros and databases, but they’re usually in idle places, like our law firm servers or on cap table software or on spreadsheets.
But, I guess, the through line if you just kind of zoom out and look at these things. They still live is ones and zeros, but just kind of in these siloed intermediary locations. And that’s where, I think, the next formatting layer is going to really be born out of. It’s this idea of locking these things from these databases and putting them on a trustless settlement layer. And this is really the power of blockchains and why I believe blockchain based securities are the next format for the legal layer.
Great. So, you mentioned, the trustless-ness of that layer, but that might not be immediately clear to people, why that’s better. Like, if I have a cap table and it’s sitting in my law firm server, don’t I want it there? Why is it better if it’s in some public... Well, maybe it’s not public, but a trustless layer, can you walk us through the benefits of that?
Sure, sure. It’s a great question. And I would say, if we look at the problems that exist with the current model, it’s probably easier to kind of grapple with. So, I would say the problems that are born with the model of having these assets live in all sorts of disburse locations. I would say that, when you try and move those assets, there’s certainly, a rent seeking from moving an asset from one location to a different location. There’s time between matching and settlement, that exists today. That creates just an inefficient use of that asset in transit. There’s also less governance rights. And this has been written and articulated by attorneys. It’s this idea that as you have your assets that you own, that are now... There’s an ownership stack that now exists and you’re at the bottom of that.
Even though, it’s your assets, there’s intermediaries, that may have stronger rights to govern those assets than you, just by way of how the structure has been formed over the last 30, 40 years. And so, in the aggregate, there’s all of these problems that really are... Stem out of inefficiency. It’s costly, less governance and rights associated with the assets. There’s the argument to be made, that idle assets aren’t the most efficient use of those assets. And when you think about them in the context of our markets. And so, this database model, where we have hundreds, if not thousands of these databases where our assets live, may not actually be the best format for them. And I see this very much as a formatting problem. I think, there’s probably a way to have those benefits of ownership and asset management exists, through ones and zeros. While still having a move more freely, be more sovereignly owned. And I think this is the idea of blockchains as a formatting upgrade.
Fascinating. I love it. So, there’s one thing that maybe I missed, but that comes to mind, that has to do with the idea of tracking components of an asset as it moves and how, obviously, this new blockchain layer is just gorgeous for that. Whereas, the old version totally falls apart when you try to follow where the shares of something go. And who had that? Did you have Excel version one or two or is it, mine the latest? Is yours the latest?
I mean, isn’t that one of the...
Improvements that blockchain is going to create for asset holders?
Definitely. So, this is really the beauty of not having to trust your assets on a ledger, but having them live on a trustless leisure. And it’s this idea that with blockchains... Because we’re not trusting a central party to manage a cap table or tell us when A moves to B and when B moves to C. Because that all lives on a ledger, that we all can look at and agree and agreed through consensus that, this is where the assets now live in are trading, in real time. There’s all sorts of efficiency gained. And one of those benefits that you’re touching on, is transparency. There’s no funny business, when you know exactly where your asset lives and can move at any given time. And with transparency stems all sorts of cost savings if you can...
If you know where your asset lives, you don’t need to have to trust the stack of intermediaries to help you get an opinion on how they can move because maybe regulations are embedded in that asset. Or they’re calling to a white list, that allows you to know who and where they can trade, instead of having to kind of get a costly legal opinion. Or to trust intermediaries to interact with each other, to facilitate that exchange. So, that transparency is really one of the key benefits that really makes and unlocks a lot of the possibilities here, Adam.
Yeah. And for those who missed it, what you just said, there was a whole other thing in there that you mentioned. That basically says, yes, transparency is amazing, but what you’re pointing out is that there’s all sorts of costly expenses that I, as an asset owner or as a company, CEO, if the asset is the shares of the company. I don’t have to incur any of those expenses because the share itself is now doing the work that all of these service providers used to have to do. And I used to have to pay them and find them and chase them down and get... All of that’s gone.
That’s a huge efficiency, that you just described.
But maybe people miss the first time.
So, I’m happy you call that out, Adam. Yes. It’s totally true. And it’s why I believe that this is really... There’s so many benefits that were unlocked from going paper to electronic, but there’s still problems. And I see these very much as formatting problems. It’s really the format that these things are taking. And really a lot of this can be solved by upgrading to a new format, which is what a lot of our corporate members work on, which is what a lot of what we see, when we talk to them. And yeah, I’d say, this is why the potential here is so exciting as a formatting upgrade.
Yeah. I love that you came up with the idea of kind of framing it as a formatting issue because I think one of the roadblocks mentally for a lot of people, is it something different? Wait, I have my digital... I have my security and then there’s this blockchain, but I don’t like blockchain because I like securities. No, no it’s a digital security.
Only, it’s still the same thing. Just format it differently. I like that you’ve called that out.
Exactly. Yeah. You nailed it. I’m a big believer in trying to find ways to communicate the value proposition. In ways that folks can understand. It’s something that you and I’ve talked about, I think there’s a great... There’s great precedence here, right? I think, memes have really kind of invaded our society and it helps us remember and share in an understanding of how things work in the world. And I think, this is just another way to explain how this stuff is so relatable and will, hopefully, provide tremendous value for asset owners all over the world.
Yeah, absolutely. So, okay, this is a good segue. So, you also, while we’re talking about coining terms, you talked about something called digital sovereignty. So...
Why is that idea important in what we’re now calling blockchain based securities?
Totally. So Adam, all this stuff that you and I just talked about, all the cost savings, the efficiency improvements, the transparency. The regulators love this stuff because they can have read access to how securities are moving through the life cycle. All those benefits, I would consider, a massive, massive formatting upgrade. And if we just stopped there, I would be super content and still believe, that this is where the future of asset management and asset ownership is going to exist. With blockchains. But it doesn’t stop there. I think, the cool thing that trustless ledgers and digitization really unlock, is this idea of digital sovereignty. There’s been a bunch of folks who have written about the possibilities. A professor, Stephen McKeon, at the University of Oregon, has written about this. He calls it, this expansion of design space and attorney Gabriel Shapiro, who’s a friend of mine, has talked about this as well.
This idea of, owning this asset more closely, the security more closely, than ever before. Digital sovereignty really comes down to this idea that, when I own my asset more closely to me than ever before. Where I don’t need intermediaries to kind of work through how they move or how they transfer, how their owned. And you rip all of that infrastructure out and you have this asset that’s just more closely held. You can start engaging with that asset and interacting and using that asset, in a trust minimized environment with which blockchains allow for. And be able to do all sorts of sovereign activities that you’ve never been able to do before. So, for example, there’s all sorts of experiments that are happening on the blockchains now, where I can, presumably, one day take my security and go to a blockchain based credit facility, without a counter party, without an intermediary. Take my asset and lock it up and use it as collateral and get US dollars back and start being able to use those blockchain based US dollars, in this trust minimize environment.
So basically, unlocks our capital from siloed infrastructure and brings it closer to us, so that we can now bring it to this trust minimized environment and start interacting with this whole new world of ones and zeros. That just wasn’t possible for, in this siloed model that we’ve had for the last 40 years, Adam.
That is exciting and there’s so many more ways that the geniuses around us are going to start coming up with.
Interact with these assets that they now have sovereignty over, to use your term. It’s exciting to see.
And some of those new companies are going to be called... What’s the name? I forgot the name. What’s the guy’s name?
The codes that were Ur-Nammu.
Ur-Nammu. You heard it here first.
So, as usual. So, is there anything else that, we think, is coming around the pike now that we have these sort of distinctions, which are like the difference in format, not a difference in actual fact? And then, maybe, the idea of having sovereignty of our assets? Any last thoughts about where that is going to take us?
Yeah, I mean, so Adam, this is the beauty of computers and ones and zeros. And how do all of this stuff be reduced down to trustless ledgers. It’s really, I think, at this point, it’s really just watching this industry evolve and watching these experiments prove out. And seeing how the regulators interact with these experiments and seeing how our legal layer evolves over time. But I firmly believe that as assets... More of the world’s ownership gets reduced down to these trustless ledgers. To these ones and zeros, we’re going to see all sorts of really cool experiments. So, things like streaming equity, let’s say you’re a startup. And all of the ownership of that startup, that equity lives on a trustless ledger that the advisors, the investors, the employees, all of those folks may be able to get streamed equity in real time. And then, as that equity accrues to them, they’d be able to now closely hold that equity that doesn’t exist on a paper. And use that equity in ways that they just weren’t able to before.
And hopefully, in ways that are 24/7. Bound, not by geography because we’ve got these regulations coded into the assets themselves. There’s all sorts of opportunity for just some really cool stuff to happen. And I think, it’s this idea that over time the legal layer and this new formatting layer will evolve in ways that we just can’t really grapple with. But it’s something that I think, you’re going to keep an eye on. I’m going to keep an eye on. Security Token Academy is going to keep an eye on. It’s a really fun space to be a part of and watch evolve.
It is exciting. And for everybody who wants to also keep an eye on it, just watch here. Because this is the first sort of interaction between Derek and me about the latest that’s happening in this space. We’re going to come up with many more to come. So Derek, thanks so much for joining us. That’s it for today’s show. Be sure to follow us on Twitter, Facebook, Telegram and Medium. Don’t forget to subscribe to our YouTube page, so you don’t miss out on any of our videos and expert interviews like this one. And a big thank you, as usual, to all of our gold corporate members as well. And we invite you to learn more about our corporate members by clicking on the directory tab and click corporate member. Remember to stay safe, wash those hands, stay sanitized. I’m Adam Chapnick, for everyone here at Security Token Academy. Thanks so much for watching.
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