Regulatory issues for oracles and prediction markets

By Tamsay | Tellor | 25 Mar 2022


Nick: Hey everyone, welcome to, I don't even know what we're calling this. just kind of a random Tellor meeting we're throwing in the middle of the week. I gave this presentation a few weeks ago I think now to the CFTC so if you guys don't know, the CFTC they’re kind of one of the regulators of cryptocurrencies. You can just like, they have, I think it's called a fintech working group or something like that, you can just go email them. And they'll take a meeting with you. So, you don't, anybody can go give a presentation to them for an hour or i think it was 45 minutes. So, they were all super cool. I also used to work there so i was a little bit more comfortable than a lot of you guys might be, but they're super chill, super nice. They give you like lawyer-like answers to everything which we'll kind of talk about, so, not that you'll get any firm answers on anything. But I like to tell people just go, go talk to the CFTC tell them what issues you're confused about. Everything like that, because you know honestly they don't, they're still trying to figure it all out too, so we shall get started all right. So oracle's, I think you guys, almost everyone should know what an oracle is if you're on the Tellor chat. But when it comes to oracle's you know this talk is kind of about regulatory issues for oracles, the structure of the oracles do matter so like whenever we say an oracle we're not just talking about Tellor, we're talking about if you have kind of various designs of oracles could there be any sort of regulatory issues there, so you can think of oracle's anything from just one person. so like, you know let's say you have a prediction market. if the team, the prediction market team themselves is the oracle. that could be, that's an oracle setup.  if you rely on one other person, so you know, you give it over to Mike here and he'll be your oracle. That works. It can also be a multi-sig so there's like, you know you can rely on three people, you can also rely on a set of white listed nodes, very similar to a white list or a multi-sig. A decentralized exchange can also be an oracle. So, if you're using Uniswap..So, there's a whole lot of different structures and depending on which sort of structure you are is probably, you're going to have different regulatory concerns along the way. So just keep that kind of in mind throughout this whole thing. So  how Tellor  works, this was my chance to tell the CFTC how my project works. you stake tokens, you report data, anybody can look at them and dispute them if they lied so yeah, and then the smart contract can read data, so if you have a prediction market say what's the weather going to be in two days, somebody, a reporter would stake their tokens and then in two days when the event happens they would report whether the weather, data that is requested. If everyone thinks it's good it stays on chain. if not, it gets disputed and somebody else puts it on chain. Pretty simple, but the keys of Tellor is it's sort of this decentralized system, anybody can use it, anybody can participate in it. It’s not sort of this model where  it's much different say in traditional finance, the way that it would work. so you know if you have a financial contract you would have, somebody would get to say what the settlement price is,  so you would usually point to, oh we're going to use Libor and in Libor is this very specific set of banks that get to control or say what that interest rate is, you could also use their services so like IHS market is one of them they use for like swaps and other contracts, or on futures contracts they say, you know,  like what's the settlement price of oil? It’s really really tough so usually they'll talk about oh it's a spot price at some specific cash exchange or it's you know something that gathers all of these prices at different spot exchanges get to report the price. how you set those up those are sort of your oracles. the difference in decentralized land and crypto land is that, you know, if you would say like, if the CME or a normal financial contract would say okay J.P. Morgan’s gonna be our oracle, they're gonna tell us what the weather data is and J.P. Morgan just flat out lies, like, you can take them to court.  There’s like, they probably did something illegal there and, you know,  you have that sort of fallback whereas in crypto land  you probably can't take your oracle provider to court if you're you know using Tellor or i mean maybe you could,  also could be a fair in a slightly interesting court case. But then at the same time if you're using Uniswap as an oracle, could you take them to court over a bad price or you know, maybe? Probably not. So, a little bit different, something to think about. Making sense so far? Cool. Okay,  some of the issues I guess when you talk about oracle's,  what are some of the issues that comes, like if the CFTC was going to try and regulate this and say something about oracles probably the biggest thing is that there's really no standards in the space kind of like i was talking about the various different models, everybody sort of does something different. And you also have a lot of problems when it comes to, so this is something i'm pushing them to sort of talk about more is just settlement prices in general and best practices around it, you know so whenever whenever this CME  they were self-certifying bitcoin futures products. So they wanted to launch a Bitcoin futures product and they had to send to the CFTC the settlement procedure so how they were going to do it and the CFTC had to approve it, so for all of these new products the CFTC would approve that, oh this is sort of a robust settlement price and you had, so they took like a t-wap v-wap across various different exchanges. They had this one firm that did this and they had all these methodologies to show that okay, like even if somebody wanted to go and manipulate the the price of bitcoin it would be very hard to do it profitably in the long run so this is sort of a robust procedure for settling the bitcoin futures contracts. Obviously that doesn't happen in crypto land, you know people are often using like Uni swap prices, spot prices, so like you'll just use the current Uniswap price which like everybody knows you can manipulate that like really easily a percent or two. Probably really easy with flash loans a whole lot. even oracles that aren't Uniswap or these decentralized exchanges, you know if you're using chain link and you know that there's only one person there, is that a risk? Maybe it's not a best practice, like what's your fallback? Do you want to have a fallback oracle? What are the risks there? People don't necessarily know what the best practices are and especially when it comes to settlement prices just sort of making it more robust so that way people can't sort of manipulate these things and hack your contracts. Which we all know, is kind of an issue. So, this was sort of what had caused me to come and talk to the CFTC so for those of you that don't know, poly market was a, I think they still are, they're a prediction market. Yeah they still are, definitely. and they settled with the CFTC so it means the CFTC contacted them and they I think that, you know they said they did some wrong and they paid the CFTC I think it was like two million dollars or something, and they agreed to sort of change some of their things. There’s a link down here we can sort of link you to that action whenever they charge them, but some of the bigger pieces whenever it comes to prediction markets and to oracles, or some of the details that they had in there. so when it comes to prediction markets for those of you that don't know, prediction markets in the us are illegal. you have to be approved by the CFTC. There are very few prediction markets so there's like a few political forecasting prediction markets that are allowed, and those are kind of for like research purposes. So you know if we're all gambling on who's going to be the president, you know there's a few kind of run by like university type organizations that say like oh well maybe it has a better option of choosing the precedence and there's some mixed research results there. But you can't just go and open a prediction market in the same way you can't go and just open up a futures exchange because they look very very similar. so you would have to go register in the US so there's what’s called a DCM or a designated contract market and that's basically what you think of whenever you think of like a futures or options exchange. You would have to go register as that and then if you're one of those, you also need a clearing organization so like a DTCC or one of these really large people who basically backstops you in case you fail. They make sure all those people are clearing your contracts, which is a whole different issue because like everything on like, Ethereum sort of clears things. Clearing means like settle so you know if i agree to send Brenda some money then you know Ethereum just does it, it's not like there's any sort of contract, or it's going to get sent in three days or has to clear. You’re not worried about anybody defaulting in the process of when we agree to it. That said, the other option is if you're not in U.S. regulatory land there's like futures and options, and then there's swaps. And what are swaps? Swaps are basically anything that's not a futures or options contract. It’s just, it's usually like not even what you would think about whenever you would think, oh this is a swap contract. Basically anything that doesn't fit into the nice clean bucket of, “you have to be a DCM.” Would be like, well it's probably just a swap so you know like, most of the D5 products like, in the poly market action they, i think they said that they would have to go register as a SEF which is a swap execution facility. Which normal people don't use those, normal people don't care about them. They’re for really big guys who do  interest rate swaps and things like that. but that would, that's like what they want them to go register as because, it doesn't. The prediction market nature of it doesn't really fit into, some of the things that they were doing doesn't really fit cleanly into,” this is a futures or options product, so we'll Just say you have to go register as a SAF.”which doesn't really make sense but whatever,  you guys can settle. And that's what they did. They settled and they're gonna work on it. But anyway, so history of U.S. regulations aside, back to the thing. The case, whenever they talked about it, you guys, if you guys did read that. They talked a lot about poly market and the reason that it needed to go register was basically that it wasn't decentralized. This was a super interesting fact because, and of course I talked to some people there and you know, they were saying well, it's not necessarily one, just keep in mind that whenever you talk about, okay well it's one thing or another. A lot of it they said was just facts and circumstances. So you know in the same way this is like a Delaware C-corp. you know, that's a fact and circumstance like, it's sort of the sum of it all adds up to needing to go register. It’s hard to really pinpoint which specific piece would make sense and that's what we want to do though. The first thing that they did, which we obviously knew was wrong. We knew from SEC actions going back to like, ether delta, they ran a centralized website that everyone was using to access and trade these platforms. That’s like always a big no-no. If you know people want to come and trade on your platform, they shouldn't be doing so directly through the website trading these illegal platform products. We knew that was an issue and they also collected people's email addresses and had  logins for it. You know, it wasn't even like, “oh anybody could do it.” They were like it was just a base website  not even not decentralized in any way. And that was sort of strike number one. But we all knew that, you know,  people we knew that would be a likely piece of contention going back to, you know like i was saying the ether delta piece. or you know Uniswap recently settled on, if you saw Uniswap took off a whole bunch of products from their website because they weren't compliant. Basically don't host products that would be illegal. And then you also had even like, the old relayers. so if you remember like, the 0x relayers. they kind of had a lot of regulatory issues just because like, even though 0x was decentralized and they were doing this thing on decentralized it was the person that was actually hosting the website that everybody knew, you're going to be the target so don't do that. But, that said, the bigger issue kind of for oracles is this kind of long word dump i put here where you know, should i read it? Yeah, any dispute or ambiguity in the market resolution, many who wins determination of which contracts are winners and losers is resolved by poly markets market integrity committee. Which is staffed solely by poly market. so whenever they say resolution process, that's who's your oracle, that's what that means. So resolving the financial contract and basically it was then, they were the oracle. And that was, it seems from reading this i mean you guys can tell me if i'm wrong, but it!seems like that might be a no-no in terms of decentralization. It’s hard to say that you're decentralized whenever they're sort of resolving it themselves. So, you know, that was a no-no. And then kind of like, okay well, what does that mean? And this is where we get into, okay well, what does, what do you know what is the regulation for oracles in this. So, okay so it's bad if you're the centralized oracle. Okay, so  if poly market is the one, we can just do hypotheticals in the poly market case. Let’s say they had a decentralized website, but they were this the sole oracle. Do they still have to register would be the question. Probably you would say, you know that would be, they're still kind of a centralized product that you can still rip off all of your customers,  if you want to. So if you're coming at it from like a  consumer protection standpoint. Like, yeah they should probably go register, that would be bad. Okay, but okay let's say well they don't want to do it, they know that they don't want to to be centralized and go register, they're going to give it to Brenda. Brenda’s going to be their oracle. So the same with, instead of them being the one person they're going to give it to Brenda. it's still, they know Brenda, they can call her. Does Brenda have to register? Do they still have to register? Who’s it on? Maybe, does Brenda like, where would she fit? We don't know. Obviously if it's Brenda, or if it's a white listed group of people, do they have to register? Don’t know. Would Tellor have to register? We don't know. and that's kind of where it stands now. So like, you know it's bad to resolve it yourself, there's a lot of consumer protection issues. If it's one person and then going on, it's not. And from our conversation with them there's almost a difference in what you do as an oracle, and this is really important. So almost like, the marketing matters. So we knew the marketing mattered like when it comes to ICOs. So you know, in the other crypto sense like, if you would say like, come invest in my shit coin you're gonna make tons of money, that's bad. But if you just put out a shit coin and said like, buy it you might lose money, that's okay. Like even though it's the exact same action it's really how you talk about it that matter. And in this case, you know in talking with them  and talking with some other people, marketing actually matters for what your oracle does. so since they were the centralized resolution service, and they sort of called them themselves that and said that they were going to make consumers whole, that's sort of a no-no. Because then you're sort of reliant on them. However, you could imagine say like, let's imagine like a perfect oracle that was just like some computer up in space running that grabbed api queries. If  that was the case and you were using this soulless data fetching machine to go get it, obviously that can't register that's just sort of this technology that you're using. So you want to as an oracle what you want to do is you don't, you want to avoid saying things like, “we're resolving markets for falling markets. We’re making sure that their contracts are up to date and we're making sure that all the consumers are protected and that they get it” which instead what you want to say is like, “hey we put that on chain. Poly market tipped our reporters and they threw it on chain.” That’s what we do, we don't know what it's being used for,  we don't know what it's in any way for or you know, we sort of hold no reservations and  we make no claims as to the accuracy, and that's kind of where you want to be as an oracle. More of this technology provider versus this. Almost a financial service platform. Which is say, more of what, you know so a lot of it does i guess have to come down to marketing. Which is not as satisfying, but i think you know, A. i would say probably puts chain link or some of the others if you're making like partnership announcements so like you would want to really avoid saying like, “we're partnering with poly market to resolve all of their markets.” Don’t say that. Or you know any of these financial platforms you wouldn't want to say that. you would just want to say like.

Brenda: Or go register right?

Nick: Yeah, you wouldn't want to say anything. You would just want to be like, they're using us. Or you know as much as like, you would use the mac or something like that. Like you're just, it's a piece of technology. and that, that's kind of how you want to be seen, so that was a big thing we took out of the meeting with them. And then, i'm like almost done already. Other pieces too, this is sort of another issue for oracle's too kind of going, I  know i'm all over the place. Going back to settlement prices. So let's say poly market has a derivatives contract that settles to Coinbases price or market. Coinbase didn't necessarily approve that. Could Coinbase sue poly market for doing that? Probably . because basically it gives people an incentive to go and manipulate prices on Coinbase. So does defining a data source make it bad? You know  if you would say like, because obviously in this case if Coinbase were to say, you know like, we’ll be the oracle and we'll put the price in or you know. You will use, we'll sign our api messages and you can put them in. This was how compound worked and i think that's why Coinbase probably moved away from it. Coinbase could say sign all of their prices and then anybody could use them in their smart contracts, they used to do this. The problem would be is that if you're using it or you the oracle, does Coinbase then have to go register or make some sort of claim as to the integrity of their markets and, i don't know if they would want to do that. And not that we would know if they would even have to register, you know going back a slide. So yeah, even Uniswap as well. So  you know uniswaps, i think they've actually calmed down as far as like pushing people to use them as an oracle. Probably for you know, they're becoming much more regulatory conscious. You know if you're an exchange and you push people to use you as an oracle, what sort of risk, legal risks do you have there?  Because is it, yeah we don't necessarily know. And yeah, i think there would definitely be some better guidelines from the CFTC for people just kind of even just educating them on, A. why you don't want to use that. And B. why it might be illegal for you to just use one exchange's prices. So yeah, I guess that would be some of the issues that oracles are facing.  Here I think the biggest piece is going to be we want to to make sure that, you know at least from Tellors standpoint going forward on the marketing, we are a technology provider. But then it also gets weird because we want to educate them as well,  just kind of being good people into doing good, making good settlement prices and actually making things more robust. So that way they also don't get in trouble. So, but that was kind of it for my presentation. Hopefully you guys learned something today. Any questions? Or how can I answer anything?

Ryan: I have a question.

Nick: Please

Ryan: I’m sure everyone's really curious about your thoughts on yesterday's executive order, but if you were to go back to the CFTC and give this presentation again do you think there would be any different guidances or is it pretty, pretty much the same?

Nick: No I mean, based on the executive order?

Ryan: Right.

Nick: No i mean, the executive order was nothing you know. Its like, yeah i don't think it really did anything. I think, you know, basically it said that the agencies are going to look into crypto, which obviously they all already are and have been. So I don't really see how it did anything. Maybe it's moving the CBDC a little closer. So you know, the central bank digital currencies. But that's like a whole other discussion. You know, happy to talk about it. But  yeah, CBDC’s in general maybe would help some of these issues because it would sort of force people to talk about them. And you know i think the biggest problem with like the CFTC’s regulations when it comes to crypto is you have these clean buckets. And they're like i was talking about, you know you're either a futurist or an options product. And then you go do this registration. Or you're a swap facility and you go and register as a swap and then everything you need a multi-billion dollar clearinghouse to back you and it's like, you know, and then you come from the crypto land and you're like, man like i don't need a clearinghouse i'm not one of these products that's ever been seen before. Where do i fit in? And usually the way that most crypto people have done it now is they're like well, screw talking to the CFTC i obviously don't fit in. There’s enough regulatory gray area and the fines aren't big enough for me to care,  i'm just gonna go with it and they go and do their own thing. You know if you're talking about from a consumer protection standpoint like, you want to make it easy for people to register and for for them to share like,  okay like these are good products. These are, these are things like, because you can do crypto products like, say even like you know financial products that are good like a Uniswap for instance. Like it's a fair financial product that's out there, it works. There’s obviously a whole lot of risks to it, but like the way that you would help that from a consumer protection standpoint would just be more kind of education and then also making sure that you know you don't have front ends listing obvious scams and things like that. So there would be ways to help that wouldn't necessarily be large regulatory burdens, especially on you know like, what Uniswap for the longest time was like 20 people and you know, Tellor is 13 people.  these teams are really small, like we don't have money for lawyers. So yeah,  any other questions?

Tally:

 What are the goals of the agencies besides consumer protection?

Nick:

So tally says, what are the goals of the agencies beside consumer protection. So usually there's like two pieces to like most of these agencies where it's like consumer protection and then market integrity. So like market integrity would be like, you want to prevent the next financial crisis. So although you're protecting consumer, if everyone is long housing, that's bad. So you have to make sure you look kind of the macro risks overall. And to be honest crypto's like, you know so even if you were doing consumer protection and everyone was like, you know you have to do an educational course before you invest in Bitcoin. Obviously if like, all of the 401ks in the world were nothing but bitcoin, that would be like a systemic risk to the system. So you'd want to pay attention to that but crypto's so tiny. I mean, I think somebody posted like what, Ethereum is smaller than the market cap of Tesla i think. It’s still you know, we're still like nowhere there. We’re like this, most of crypto like we're the size of like two banks. Like all of it. So it's just we're not quite at the size where we're going to blow up an economy. We’re basically just going to make a bunch of 20 year olds broke. But you know it's probably not integral to market stability. I think like, yeah like some of the bigger issues would be people pushing probably the bigger issues for crypto is and when it becomes kind of a risk is once wall street does jump on and then we start financializing all of the products. So then you know you get like a leverage,, you get like crazy leveraged bitcoins and things like that, and people start trading them and making more traditional financial products out of them. That’s where you're gonna have some of the bigger risks. You know or just not using it in general like some of some of the bigger risks with settlements on like the bitcoin futures whenever you know they were certifying those, it came about like well what do you do about finality? Like, technically you can settle a futurist contract and then they can like, go and revert the entire thing if they hack the mining network. So you know, you could, does it still make sense? And like, can you even do products on bitcoin because none of it's actually final. Like, because a lot of these products that there was a whole lot of talks back in you know 2017 2018 about like what physical delivery of bitcoin meant. Because you know, so if you had like a physically delivered product of corn, you know so you can buy like a corn futures contract and like there's actually going to be like a giant grain silo of corn that gets delivered to, from some farmer to some producer and you know can you do those kind of financial products on bitcoin? Some people said yes but other people were like well it's not finalized ever. Like theoretically like none of the bitcoin blocks are final so you could you go back and reverse them. so who would be at fault there. Anyway, rambling again. Make sense?

Tally:

Yeah

Nick:

 All right, anything else? Spuddy, you turned your camera on. Nope, spuddy doesn’t have anything.

Tally:

What are the disadvantages of pursuing action from the regulator standpoint?

Nick: So, Tally says what are the disadvantages or advantages from pursuing regulation. So  the biggest thing with kind of crypto in general is that they've had this like hands-off approach where they haven't really come down hard on the hammer. In a lot of ways you know especially under the trump administration they wanted to seem very pro innovation. So  like you don't want to look like you're squashing the next facebook. That would be bad, you want to make sure that your country's competitive but then at the same time you want to sort of go after things. I think A. Just manpower wise there's so many crypto projects you can't, they can't possibly go after all of us. And we're also, like i was saying we're really really little so l, you know like if I think like you know what did, there were  multiple billion dollar fines like over the past few years from other large banks and like they frequently pay these ridiculous fines, that like are more than entire market caps of the top coins. So you know does it make sense to put your staffs time and energy into this? Probably not yet. You want to a little bit. And then also, before they understand something they don't necessarily want to give too much guidance on it. being it's really nice from a regulatory standpoint when you can just say like, we're allowed to go after you no matter what. So  like just don't mess up, you know this. It’s like you know at the same way like police in general it's always really nice for them to say like, well you're jaywalking or you know disorderly conduct or something like that. Like they always have a reason to arrest you if they don't like you and they'll probably get away with it and they like sort of having that flexibility whereas if you nail down the rules completely you get a whole lot of problems because then it's clear what people have to go around. So you know in like traditional finance they've sort of backed themselves into corners in a lot of ways. Where you know they lay out the rule set in a lot of ways and then they try and pass a new rule or try and charge somebody, and then the bank that they're charging with something, comes back and sues the agency for charging them with something. And  then you know the whole thing goes to trial or they end up settling for a minuscule amount, it's just much better if you're like, actually you guys do have to go fit into these buckets. Don’t make us mad or we're gonna sort of force you to go fit into these buckets, but you don't. And i think that's a big piece of it. So, awesome.

Ryan: I got one more question actually, you talked a lot about  just kind of like Uniswap,I feel like the general consensus is that you know it's decentralized. There are AMMS and they even have the t-wap to kind of mitigate the risks. So what kind of risks are you referring to?

Nick: I’ll stop my share. Well kind of just the risks of an attack like on any exchange so the biggest risks with a Uniswap or something like that using them as an oracle is like what happens if the liquidity all dries up? There’s not really anybody, you know they're super easy to attack, there's not a whole lot of liquidity. And a lot of the times the liquidity provided on these things is just a handful of people. So even though it is decentralized and anybody can come on and provide liquidity. If  you're relying a lot of the reason people rely on uniswap is like, oh, well it can be super super fast so you know we can just rely on it to always be up to date. You know what happens if those main five liquidity providers pull their liquidity from Uniswap, and then all of a sudden 95% of the liquidity is gone there and now your contract can be thrown for, you know, a hundred thousand dollars. They can you know, double their  earnings on a derivative contract, that would be a bad thing. So, definitely that's more of the risk in my mind. When using one of these things it's more, you can use uniswap but if you do like a nice t-wop or you have backup oracles, like that that can sort of work. But using just like a spot price on an exchange you're really reliant on a whole lot of things going right. So, cool. Anyway, all right well thanks everyone for coming. I see some other people in the room so thanks everyone. And yeah, talk to you guys soon.

 

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