A VC's Perspective on Crypto & Policy

Good morning to everyone still interested in the future of crypto, despite some suggesting we may all be psychopaths. This week, Nic Carter joins us to share his perspective on the state of crypto adoption, how policy impacts his investment decisions, the 2024 election, and more.

Nic Carter is a Founding Partner at Castle Island Ventures – a venture capital firm focused exclusively on public blockchains.

Prior to Castle Island Ventures, Nic worked at Fidelity as a crypto asset investment research analyst before building Coin Metrics.

The interview below aims to shed light on how an entrepreneur and investor is viewing the state of crypto and policy in the U.S. The Q & A that follows has been edited lightly for clarity, with certain sections emphasized in bold.

Question 1: How did you first become interested in blockchain technology and what gave you the conviction to build you own business and investment firm in this space?

A1: I started mining DOGE on my gaming rig in college. I just thought it was interesting and fun. Later, I became focused on Bitcoin, especially the emerging ideology underpinning the network. Around 2015/16, I became convinced that I wanted to pivot my career to focus entirely on Bitcoin. I went to business school, started a project called Coin Metrics, and wrote my dissertation on cryptoasset governance. Through that, I was lucky enough to get connected to the early crypto team at Fidelity, and then ended up leaving and starting Castle Island. From what I recall, there was never any real question as to whether I wanted to work in crypto – I was just totally consumed with it and knew 100% that that’s what I wanted to do with my career. I couldn’t imagine doing anything else. I’ve always been entrepreneurial and knew I wanted to start a business, although I didn’t at the start realize it would take the form of being a VC.

Question 2: Where do you think blockchain is in terms of its long-term adoption potential by main street and wall street? (e.g., early innings?)

A2: Bitcoin – mature. It’s almost fully integrated into the mainstream plumbing of finance and asset management.

DeFi – very immature. Unclear whether it comports with the current paradigm of financial surveillance, KYC, etc.

Tokenized RWAs– still early on the journey, but promising signs this year.

Stablecoins – getting there! Seeing extremely fast adoption of stablecoins among major payment networks, banks (ex-US).

Question 3: What are some projects you are most interested in at this time and why?

A3: Bitcoin of course, and the emerging L2 ecosystem on Bitcoin. Hoping we see “true” rollups on Bitcoin sometime in the next 12 months, tracking BitVM v2 closely as an enabler there. Restaking on Bitcoin which can share [Proof-of-Work] security for [Proof-of-Stake] chains (like Babylon – full disclosure, we are investors) is also exciting.

In terms of DeFi, Solana is my main ecosystem focus. The monolithic viewpoint seems to be winning out, and most founders we talk to that are building crypto-native companies are opting for Solana (and other newer high-throughput blockchains like Monad).

And all things stablecoins. They’re about 80% of my focus at the moment. In particular I’m interested in fintech adoption of stablecoins, especially in emerging markets. This is a domain where crypto is making a real, tangible impact on people’s lives. We don’t have to talk in circles and be abstract – stablecoins simply make transacting cheaper, faster, and more efficient, especially in cases where payment networks are sclerotic or inefficient. In terms of specific projects I am particularly interested in the emerging cohort of natively interest-bearing stablecoins.

Question 4: To what extent does the current lack of regulatory clarity at the federal level affect your team’s decision making when it comes to when and where to make investments?

A4: It’s paramount. We of course invest through the cycles regardless, but the lack of clarity – and of course, the open hostility to crypto in Washington – is a significant barrier to founders starting and growing their businesses, and general adoption. We increasingly look abroad for deals although we would prefer to invest in the U.S. The lack of clarity makes investing in tokens tricky, as current interpretations of securities law force founders to make their tokens empty husks instead of actually useful financial products with cash flows and meaningful governance.

And of course regulatory policy in this country is holding back crypto adoption via banks, both through initiatives like Operation Choke Point 2.0 and bad rules like SAB121.

Stablecoins are also still in the wilderness due to a lack of legislation. We believe that the crypto industry would be significantly more vibrant and founder-friendly if Washington could pass any rules whatsoever.

Question 5: Drilling down on more specific policy issues, you’ve written about the advantages of private, permissionless stablecoins. As Congress continues to debate stablecoin legislation this year, what key principles would you like to see in any bill that could get signed into law?

A5: Without commenting on the particulars of the draft bill(s), the most important thing is upholding the cash-like properties of stablecoins. This means maintaining the status quo of stablecoins which some have dubbed ‘permissioned pseudonymity’ – that is, issuers know who is creating and redeeming stables, but [peer-2-peer] transactions on the blockchain are largely private and unrestricted. This is analogous to how physical cash works. Note that this paradigm is compatible with financial enforcement needs, as major stablecoin issuers do have freeze and seize functions which they use to combat illicit finance.

It’s vitally important that as finance is digitized, we retain the ability to make cash-like transactions. This has largely been lost since the 70s due to developments like the Third Party Doctrine and the [Bank Secrecy Act]. Stablecoins are our best bet to bring back the important qualities of cash in the digital world.

Other than that, I would hope to see a state path for chartering stablecoin issuers. Fully federalizing stablecoins is unnecessary and marginalizes the important role the states have played in banking regulation in this country. And lastly, I would hope that any such legislation would not erect any insurmountable barriers to entry for new issuers. The worst case would be a coronation of incumbents which would reduce the vibrancy and competitiveness of the sector.

Question 6: Combatting illicit finance transactions that involve digital assets is an issue that has been top of mind for many Members of Congress. What are some ways policymakers could address these concerns without unduly stifling financial privacy and innovation in the U.S.?

A6: Crypto comports well with the need to combat illicit finance. Blockchain transactions are indelible and highly legible. Companies like TRM and Chainalysis have developed sophisticated tools to combat illicit flows on-chain. Compared with illicit flows via banks or cash networks, crypto offers a better experience for law enforcement. This fact pattern is quite well established at this point in my opinion.

Question 7: You’ve also written about “Operation Chokepoint 2.0” (See “Operation Choke Point 2.0 Is Underway, And Crypto Is In Its Crosshairs” article from Feb. 8, 2023). Do you think there is still a coordinated effort by banking regulators to deny crypto firms access to banking? Why or why not?

A7: Yes, this is still very much ongoing, and it’s broadened beyond just crypto towards embedded finance, fintech, and really any banks that support or sponsor technologically-enabled banking. Banks that serve these kinds of partners face a significantly higher risk of FDIC examinations or recriminations from the Fed and other financial regulators.

Gruenberg, who presided over OCP 1.0 and 2.0, is still the chair of the FDIC despite his pending resignation, and banks are still faced with deposit caps for crypto-focused clients. This is a huge headwind holding back the industry, and a very regrettable one. From the perspective of a VC this is the number one issue holding back our [portfolio companies] – it just makes building a crypto business in the US much more capital intensive, especially if they depend on any kind of transactional banking.

Question 8: Some in the crypto community are hopeful that if Vice President Kamala Harris becomes President, there would be a “reset” in the current Administration’s posture towards crypto. Do you see this as a likely possibility? Why or why not?

A8: I think that’s incredibly unlikely. VP Harris hasn’t herself made any comments about crypto. All we’ve heard are musings from her aides that there could be a rapprochement. Harris was the most liberal member of the Senate under her tenure, and even though she has made noises about moving to the center with her platform generally, I don’t think she changes her stripes that easily. The fact that Ramamurti (an infamous Warrenite and a noted crypto skeptic) is advising her campaign is also troubling. I see no reason to assume that a Harris admin would be any warmer towards crypto (ultimately, crypto itself is generally at odds with the progressive viewpoint, in my opinion). I think the notion of a reset is wishful thinking on the part of Democrats that work in the crypto space.

Question 9: Others in the community are concerned that while Former President Trump has promised to be a strong crypto-ally on the campaign trail, he may be merely paying lip service to the crypto community to garner the crypto vote and campaign donations. Do you share these concerns? Why or why not?

A9: I think this is silly. First of all, under Trump, crypto policy was considerably better (Brian Brooks passed the Fair Access rule prohibiting Choke Point style behavior for instance). And the Republicans have made a full commitment to the values of crypto as part of their platform. Trump of course has explicitly endorsed crypto and made very specific promises to the crypto cohort. His VP JD Vance is a Bitcoin holder and clearly very aligned. Other folks in his circle like Ramaswamy are also authentically pro crypto. Trump and his family are active crypto entrepreneurs even, via his NFT project and his son’s DeFi project. Trump couldn’t be more pro-crypto if he tried.

And there’s the matter of the Senate. If Republicans carry the Senate, it’s virtually guaranteed that we get meaningful clarifying legislation – and even in the case of a Harris victory, the Genslers of the world would not be confirmed.

Question 10: What resources would you recommend to individuals who want to know where candidates for House, Senate, and White House stand on crypto policy ahead of the 2024 election?

A10: I like Coinbase’s Stand With Crypto database which has ratings to see where various politicians stand on crypto. Although it’s worth noting that political views on crypto are fluid and some may be opportunistic. Generally, my view is that we should first and foremost support the industry champions that have a multi-year track record defending the industry and writing legislation that will help it thrive domestically.

******

Thank you for reading. Enjoy your Labor Day weekend!

-GSL