Interview: How to Build a Bank in a Startup City

Sean Pawley on writing financial regulation from scratch, building a digital bank, navigating a Honduran special economic zone, and why Mars sucks.

You’re reading Startup Cities, a newsletter about startups that build neighborhoods and cities.

This week features the first of many interviews. These interviews focus on innovations enabled by Startup Cities as well as innovations that enable startups to build cities.

I have a few goals for these interviews:

• To take innovators seriously, even if an idea sounds weird.

• To ask the questions that an intelligent skeptic would have about an idea.

• To go deep. No grand “TechCrunch visions”. How does the thing actually work?

In other words, I want to pursue the opposite of the superficial, cynical, “gotcha” interviews that plague tech journalism.

I welcome your feedback on these interviews and my interviewing style. Let’s go!

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Sean Pawley is founder of Nekhbet Resources in Uganda and Seshat Bank in Próspera, Honduras.

Themes:

• Taking on Legacy Banks in Latin America

• What about the money launderers?

• Writing a new regulatory environment from scratch

• Metaverse Bank Lobbies

• The FDIC has no money

• DeFi, NFTs, and DAOs

• The geopolitical risk of Honduras

• Why Mars Sucks

This interview is long. But it’s broken into chunks. I encourage readers in a rush to find a theme that interests them and go straight there.

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ZC: Who are you and what are you building?

SP: My name is Sean Pawley and I'm the founder of Seshat Bank. We're building a full service commercial bank right here in Próspera, Honduras.

ZC: What's up with the name? What's a Seshat?

SP: *laughs* Seshat is the name for the Egyptian goddess of accounting. She has a few different names, but Seshat is the shortest name that she went by. I thought that the goddess of accounting and ledgers was an appropriate one for a bank.

ZC: You seem like a history buff. Have you drawn on any historical precedents for your decision to join the Honduran ZEDEs or to build your bank?

SP: I wouldn't say I was inspired by or draw any historic parallels between my bank and the ZEDE ecosystem. I would say that the ZEDEs themselves and decentralized governance in general is a bit of a return to the historic norm.

As for the reason why the bank is being set up within the ecosystem, that’s pretty much exclusively for business and legal reasons. There's not really a good historic equivalent to how I’m structuring the bank.

ZC: There’s no historic equivalent to Seshat Bank?

SP: I wouldn’t say no historic equivalent. We’re not too different from large commercial banks in the US as far as internal risk management practices go. In the broader picture though, banks evolved from using bills of exchange to generate pretty much all of their income, like with the Medici and the Italian banks.

Banks found ways to get around prohibitions on interest. Bills of exchange were essentially a loan that instead of using interest would fix forex rates at a future date for whoever was borrowing the money.

That business evolved into that bankers would lend money to governments in exchange for a claim on the income of a given asset. Someone may lend money to a government and they will receive the income of the port of Calais for 10 years. Or in the case of Jakob Fugger and his family, they would lend money to the Hapsburgs and they would gain control of the income from several silver mines for a certain period of years. At the same time banchi di pegno (pawnshops) started popping up offering loans against collateral - typically jewelry or gold.

In the modern U. S. and the European Union and to an extent in China there's quite a bit more focus on cash flow analysis as a way of determining what companies are actually suitable to lend to.

But here in Central America banks are still essentially still just pawnshops which is not really a very good way of doing banking. Pawnshops have fairly high default rates — they’re bad at spotting bad borrowers — and miss out on a lot of otherwise good companies (e.g. any company with subscription revenue and low churn).

ZC: What do you mean banks are pawnbrokers?

SP: What I mean by pawnbroker is if you want a $100 loan, you better come up with $200 in collateral to get that loan. It's not a very good way of doing banking.

Taking on Legacy Banks

ZC: Are there other problems with legacy Latin American banks that convinced you to innovate in this space?

SP: I originally decided to start the bank because of the problems I had with East African banks.

Luckily the problems that people here in Central America are having with their banks are pretty much identical to those that people in East Africa have with their banks. A lot of problems have to do with Honduran banks not really thinking through how the internet can change the user experience and some of the unique things you can do with computers that you can’t do in a branch.

Let's say you have a Honduran Lempira current account with one of the local banks here. You want to open up a USD account that can receive money from the U. S. That doesn't dramatically increase your risk from a money laundering point of view. But the banks here do typically refuse.

And they may not refuse outright, but it's going to be a big process to get you access to that account because they're fearful of some kind of money laundering activity even though nothing about it dramatically increases your risk profile.

I think that a lot of the problems with the way the banks here run is that they try to replicate the branch experience online and in their mobile apps instead of thinking about how the internet can change the experience for the better for the customer. They duplicate a lot of the a lot of legacy systems they had.

It’s a pain in the ass for fintechs or companies in general to do build any kind of applications on top of bank payment rails. Getting API access is like pulling teeth with them. Any kind of online card processing is a nightmare as well.

Another - and probably the biggest issue with the banks here - is that they haven’t really thought through their underwriting process.

Most banks have fairly simple rules for loan approval if you aren’t friends with the bank’s president. 20% discount for real assets, 50% for machinery, 80% for movable assets, etc. After collateral (less discounts) is taken into account, banks will approve an equivalent loan. This leads local banks to be way way overexposed to real estate prices. It also makes them lend to otherwise non-creditworthy businesses and miss out on some good ones.

ZC: On the Seshat Bank website, you mention that the product is API first. What does that mean? Why would it be important for a bank to treat APIs as a first class citizen in its product?

SP: I’ll sound a bit trite saying this — hardly a unique observation — but money is just numbers moving around the ledger: either within our ledger, the ledger of our correspondent partners, central banks, etc. In the case of the various cryptocurrencies it's literally just bits in a decentralized ledger.

The API first model actually allows people to start building and programming the way they interact with their deposits. It opens up a whole new world of possibilities for them, it lets them much more easily control their company's revenue and expenses and lets them actually track everything that's coming in, everything that's going out. Banking is a platform business and there's no reason why people and businesses shouldn’t be able to easily integrate third party applications with their account.

It changes a lot of things that only talk about money into things that actually interact with money.

ZC: What do you mean by “interact with money”?

SP: Invoicing, inventory, and supplier management software are great examples of things that typically talk about money but rarely actually directly interact with money. They talk about how much you should have in your account, how much should be sent, but oftentimes have no way of actually confirming or interacting with anything.

But if you directly integrate with the bank itself, instead of just talking about the amount of money in a bank account, you’re interacting directly with the money. It opens up a world of possibilities for software developers.

What About the Money Launderers?

ZC: It sounds like one of the benefits of an API-first approach is that it can help customers operationalize their money and make it legible. But if there's anything I learned living in Latin America, it's that a lot of people don't actually want their finances made legible.

A friend and I used to play a game in Guatemala City where we’d guess which businesses were money laundering operations. You could tell that there was something off. There’d be some little store with way too many employees, for example. Or you’d see the usual Panama-City-style big empty apartment building. Eventually we’d know if we were right when a news story came out about the owners getting arrested.

Is there a tension between the nature of managing money in Latin America and the nature of this technological innovation that you're doing, which makes money more legible?

SP: You're correct that we’re making money more legible. We're making it more legible to us, to our customers, and to money laundering authorities within Honduras and internationally. It is increasing legibility. With regard to money laundering specifically yes, Honduras is a hot spot.

We’ve spent a fortune on developing internal AML [ZC: “Anti Money Laundering”] procedures and talent to identify, block, and report launderers to authorities. I’ll note as well that we follow U.S. AML standards, which are stricter than Central American standards, in general.

But I would say that the primary benefit is not so much operationalizing your money. While being API-first does make it more operational and that is nice, I would say the primary benefit is scaling your money. You're able to perform many, many more transactions and types of transactions if you are able to program your money than if you're interacting with your bank manually.

ZC: I'm the relatively poor proprietor of an informal corner store in Honduras, why would I do business with the bank? What's the pitch?

SP: Well, you probably wouldn't do business with us if you're running a corner store. We're not able to support any cash payments that your customers may give. We're not able to support a lot of the things that you as the owner of a corner store may need.

Just given the cash driven nature of the informal economy, the corner store has needs that we would not be able to support. Our typical clients are much much larger than that.

Our target market is primarily industrials, importers, exporters, agricultural firms, software companies - companies that don't need to actually deal in cash, basically.

ZC: OK. So I'm a rich Latin American oligarch that owns a bunch of fincas (agricultural operations) and some import/export operations. Same question, what's the pitch to me as capitalist?

SP: Right. So the pitch to one of these large firms is going to vary a bit depending on the industry. The simple pitch is that we make it much easier for them to handle inbound and outbound payments and in general are able to offer faster turnaround times (and maybe better terms) for financing given our internal analytics and tooling.

For many of these businesses payments are a huge pain point. Not even so much the cost of payments, just dealing with the actual headache of paying suppliers/employees and easily tying an inbound payment to an outbound product or service delivery. We eliminate as much of that pain as possible.

For example, if you're managing an agricultural firm or a manufacturing firm you're dealing with suppliers that you don't necessarily trust. We have escrow accounts available for our customers. These are 2-3 multi-sig accounts with dispute resolution provided by Próspera arbitration.

Let’s say I want to send $100 to Zach but I don't necessarily trust you to deliver. This account is going to have a duration of five days. At the end of those days, if I haven't released the funds to ZC, the funds will revert back to me. I input your email, you'll get an email. At that point you click on a link, you're able to either set up an account with the bank or you're able to input your own bank information.

At any point during those five days I can release the funds to you or let it expire and let it return to me. Either one of us can issue a dispute to the transaction, if we feel the other party is doing something shady.

If a dispute is entered, we just freeze the account, bump it up to Próspera arbitration. A couple of weeks later, you get a judgment back. Whichever way the judgment goes, we send the money to whoever Prospera arbitration specified.

Escrow basically enables commerce between people who do not actually trust each other.

ZC: So that’s escrow. But Seshat promises more than that.

SP: The pitch on the lending and financing side is this: with the dataset we collect about companies we're able to much more accurately estimate what their cash flow looks like than existing banks. So we're able to issue loans with lower default rate: higher quality loans at lower cost with faster approvals.

For deposits it's that we don’t subject you to all the nonsense the other banks here put you through.

For payments it's a bit more complicated, but in general we make it easy to send and receive money to and from anyone.

The bank is a bundle of products that taken together comes out to a much, much better package than they're getting with the other banks here.

ZC: For people to understand the value proposition of something like your digital escrow, or having arbitration built in, we have to set the stage for Honduras and the ZEDEs. The ZEDEs are essentially special economic zones on steroids. Honduras has lots of these things — called "ZIPS" and "ZOLIS" and such.

But the ZEDES have this legal and regulatory element built-in. This is the real enabler for what you're doing. How'd you find out about Próspera? What were the specific value propositions that attracted you and convinced you to move and build there?

SP: I've known about Próspera for quite a while actually. I've been in the startup city space for a while so I'm familiar with most of the projects that are going on in it. As for Próspera, the big things that attracted me to it were the legal and regulatory environment for banks.

We worked with Prospera to craft the legal and regulatory regime that fits in with international standards. It meets a lot of the things that we're looking for with regard to risk management.

Writing a Regulatory Environment From Scratch

ZC: You were able to write your own regulatory environment? How did that work? Were you able to choose an existing regulatory system or bits and pieces of existing ones? How was that valuable to you?

SP: In discussion with the Government of Próspera, companies are able to propose a regulatory regime. They propose it to the Council of Próspera.

If they feel that any one of the 20 O.E.C.D. regulatory regimes are inadequate or not as good as they should be then they can propose a new one to the Próspera Council. Prospera Council needs to approve and then the CAMP — which is the regulatory body governing the ZEDEs — needs to approve as well.

We proposed a regulatory regime comprised of American money laundering laws, which are very strict as far as reporting requirements go to combat money laundering.

We felt this was key to getting acceptance of what we were doing here. We operate on a much much stricter level. We have a much stricter compliance regime with regards to money laundering than other banks in Honduras do.

With regards to risk management we proposed a regulatory regime based off of Mervyn King's work. Mervyn King was the former governor of the Bank of England.

King wrote a book called The End of Alchemy, which proposed a novel regulatory regime for banks that eliminates a lot of the liability. It eliminates all of the risk to current depositors and holders of bank current liabilities.

It makes banks be much more conservative with their current liabilities, but they can be much more creative and flexible with their long term capital than the current regime.

Our licensing and liquidation regulations are pretty standard and basically the same as any other countries.

ZC: The Próspera Arbitration venue is a service offered to businesses within the ZEDE. My understanding is that this is essentially a commercial arbitration center.

It's led by a Honduran lawyer who was trained at Harvard with his team. What is it about this private arbitration arrangement that is attractive to your bank and why would it also be attractive to your customers?

SP: Do you know the Foreign Kings problem? Basically it's that you don't necessarily trust the local kings to resolve a dispute that you have with your neighbor. There are all kinds of biases, there's all kinds of history.

But with a situation like Próspera, a lot of the judges are not actually here in Honduras. They're internationally located. They don't have any local history. That's a pretty big benefit if you’re concerned about bias in the legal system. There's no bias involved in the arbitration process. The other benefits are cost and speed. Those are big ones, particularly for the aforementioned escrow accounts.

I think a lot of the disputes are probably gonna be something less than $100,000. Being able to upload your evidence to Próspera Arbitration, have your attorney make your case, and then get a judgment back and have the money go either to you or to the opposing party very quickly. I think that's a really, really good quick way of just establishing trust.

If you still dispute that, you can just appeal the judgment either before another Próspera Arbitration Tribunal or you can just take it up in the ordinary Honduran court system.

ZC: Interesting. Having done some business in Latin America I think basically all entrepreneurs try to avoid the courts. That is, unless they're trying to saddle a competitor with one of these expensive, never-ending lawsuits. The standard courts feel more like a weapon than they do a service that's about resolving the dispute.

So why would anyone appeal into the Honduran courts? Would that ever be a rational thing to do?

Let's say it's not rational, then why should a foreign investor believe that Próspera will be less biased given that I'm unlikely to appeal?

SP: I wouldn't be surprised if there are some appeals. Particularly if there are any high ticket disputes. If you're arguing over a sufficiently large sum of money, well, it can pay to keep the legal fight going for a while.

As for why foreigners are attracted to Próspera specifically, well, if your counterparty is Honduran and can appeal to the ordinary regime, it may be difficult for you to effectively argue your case in their courts.

And the biggest reason is because you can already point to a judgment from a mutually agreed upon arbiter that's ruled in your favor before. That goes a long way with the courts here. It doesn't necessarily mean that you will win. They may conclude on their own that the arbiter was in the wrong and all of that, but it helps your case quite a bit.

Anyhow, you can also agree with your counterpart beforehand to present any appeal in another Próspera Arbitration Tribunal, and only have to deal with the ordinary regime for a potential final recourse against a ruling, called Amparo, before the Supreme Court.

ZC: Interesting. One of the big criticisms of the ZEDEs and Próspera is that people are just trying to escape regulation. It's about a "no rules" Waterworld, Mad Max place.

But it sounds like you’re adopting the a gold standard of AML/KYC related to anti-money laundering rules from the United States. And you’re voluntarily opting into a stringent regulatory regime based on Mervyn King's work. This regime forces you to be more conservative with your depositors money. Have I understood that right?

SP: Well, it forces us to be more conservative with our current liabilities. If you put money into a term deposit account with a 3, 5, 7 year duration we can be much more creative with how we invest that money and how we lend that money out than a traditional Honduran bank. But with our current liabilities, yes, we do have to be much more conservative in general than your typical bank would be.

As far as the ZEDE being a kind of anarchic place and all that, I mean it's a criticism, but it doesn't really have any basis in reality. Like if you're looking at Próspera, you know, I feel like half the staff there are lawyers.

There's the entire UCC governing commercial transactions. The ZEDEs are just an effort to take government and make it better. That's what it is. So I don't really know where the critics are getting these ideas from. It doesn't match up with reality.

ZC: On your site you describe Seshat as "the business bank for the ZEDE ecosystem." This doesn’t mean that your customer base is primarily other businesses in the ZEDES, right?

SP: That's correct. We can accept businesses from anywhere in the world so long as they pass our KYC / KYB standards. We can accept clients from all over the planet. There are restrictions about how we can do outreach and things of that nature. For instance, we cannot set up an office in the United States and advertise.

ZC: Why can't you?

SP: Well, I suppose we could do that. We would just have to go through the whole federal or state bank chartering process. If we were to start operating in different countries, then, we would have to abide by those countries' legal standards and by those countries' licensing regimes. So as a general rule people from these countries can approach us, but we can't approach them.

ZC: So could you do a Facebook ad campaign where you market to people like me? Can I see your ad and say "Hey I want to put my money in Seshat Bank?"

SP: That would would be frowned upon. That would be against the law.

ZC: Are there benefits or innovations around yield to depositors?

Every young-ish American has grown up in this world where putting your money in the bank gives you basically no benefit. You make nothing on your normal deposits. Really, you lose money to inflation.

So everyone goes and buys index funds or Bitcoin. Are you able to offer something more attractive than the median American bank for a standard depositor?

SP: Yeah I'd say so. Again, we wouldn't be targeting Americans with this but for our USD term deposit accounts — which are basically our CD equivalent — we'd be offering 4% to 6% interest depending on how much money you're depositing and how long it's going to be locked up.

Seshat Bank as Innovator’s Dilemma

ZC: OK. Latin America is a massive remittance market. Your demo video shows a nifty send/receive money feature. Does that mean that you're able to service remittances?

SP: Yep. So if someone down here sets up an account with Seshat Bank then their family back in the U. S. can wire the money directly into their account.

Western Union or any of the remittance companies can easily integrate with us and their clients can receive payments instantly into their accounts with Seshat Bank. That's not really a core market that we're targeting though. We're going primarily after commercial businesses, but that is a group that we can service.

ZC: Why would Western Union integrate with you? Or do you not take a cut?

SP: We don't take a cut of any inbound money. If you send money to us, we don't charge any fees. Intermediary banks may charge fees, but we do not.

Western Union would probably only want to integrate with us after we hit some critical mass of remittance recipients. Like I said though, it's not a market we’re really targeting so I don’t have any timelines or figures on that.

ZC: So let's project out seven years from now. Seshat Bank bank is successful in growing this "throwaway feature" of free send/receive money. Surely that seems to be quite dangerous to a player like Western Union, who is well known to be kind of an angry gorilla in the Latin American market. Right?

SP: We don't charge any money to receive. But if you're wiring money from the US to Honduras, the bank that you're sending from, they'll probably charge a fee. It's not going to be instantaneous like Western Union is. It'll take however long it takes just to get through intermediary banks to us. We wouldn't charge any fees.

I don’t really see us as a competitor to Western Union. To compete we’d have to get MTLs in every state which is, well, it’s a pain to get. We’re the endpoint in the transaction, Western Union is the intermediary. Western Union is more of a potential partner, not a competitor to us in that space.

Metaverse Bank Lobbies

ZC: Traditionally banks invest in heavy physical footprints. They get a fancy office downtown, they fill it with like Ionic columns and expensive magazines and upholstered chairs. All of these are signals of trust and stability.

It seems like you're not going to have those traditional signals of trust and stability. Are there digital equivalents to these signals or other things that you're thinking of that are able to carry that same message?

SP: The digital equivalent is having an extremely well designed and safe application and website. If you have an application that shows that you've clearly put thought into how it functions and that shows you've spent time and really thought about everything that you're doing, that’s the digital equivalent of it.

Apart from that though, there's no way of having this massive lobby in your office. There's no real digital equivalent to that. It's just making sure your software does a good job and that is very, very well designed.

Our arts team is making some artwork we’ll be displaying on our social media, on our site, etc so maybe that will be the equivalent? I don’t think so though.

ZC: So no epic metaverse VR lobby?

SP: I don't think we'll be taking Facebook up on that offer.

*laughter*

The FDIC Has No Money

ZC: Modern banks exist within all sorts of socialized risk policies and guarantees.

This includes deposit insurance like FDIC in the United States. Or what we saw in 2008, which is an implicit bailout guarantee. I assume Seshat bank can’t rely on those things even to the extent that they might exist in Honduras because you're inside the ZEDE.

Is that right? If so, how does this change your strategy and attitude towards risk?

SP: Well that's not quite correct. First, I would not describe the FDIC itself as being a socialized risk program. It does pool risk. But the FDIC right now is only able to protect community banks.

Last time I checked, the FDIC only had about $70 billion dollars in capital. This doesn't even come close to making a dent if one of the major banks or if one of the national banks was to go down. It's only large enough to pay for the deposit insurance on fairly small regional banks. [ZC: Industry reports suggest that this grew to $121 billion in 2021. The point still holds.]

ZC: But that doesn't mean that the guarantee isn't there, right? I mean we know that with many entitlement programs the money isn't there.

But a guarantee of sorts is there. And I think when most people go into a bank and they see “FDIC Insured,” they do not know what you know — that there isn’t enough money to actually service the insurance.

So there is a sense in which there’s a backstop, a guarantee. If a bunch of banks failed the government would probably borrow or print or otherwise come up with the money necessary for the $250,000 per account guarantee.

Do you disagree with that analysis?

SP: Well no, I agree with you that there's probably a soft government guarantee. The FDIC is mainly a consumer confidence program. The FDIC does not have the money to actually back up the guarantees that it makes. And it's really, really hoping that it never actually has to honor its commitments.

With regard to the Federal Reserve and with regard to the bank bailouts and all of that... that's actually a subject we have spent a considerable amount of time on. Mervyn King addresses it in The End of Alchemy quite extensively.

Every single central bank on the planet has this role of lender of last resort. If a bank is facing liquidity problems, if there's a run on the bank, this bank can come to the central bank and say, hey, I just need some money.

We temporarily have more money going out than we have coming in. We don't think that we're going to have the cash on hand to prevent a run on the bank. So they go to the central bank and the central bank says, sure, here's the money and I’ll take an equivalent asset value as collateral.

Now there are a lot of problems with that. For starters, central banks tend to not actually have the degree of insight into the bank's operations to determine an appropriate discount rate on bank assets. Central banks do not have the level of transparency with banks necessary to do an effective bailout of those banks.

They don't have the knowledge necessary to determine what an appropriate haircut is when the bank is positioning assets with the central bank as collateral for those short term lenders of last resort loans.

We operate under a different model which Mervyn King describes as the "pawnbroker for all seasons model." Basically, we need to pre-position bank assets with a 3rd-party lender or central bank.

This third party lender or central bank is going to take a look at our assets and it's going to assess the quality of those assets and what they think they'll be able to sell them for in the event of a crisis, if the worst happens, what is this asset worth. They have a lot more transparency with us than with banks under the traditional regime as far as our risk management practices are concerned.

So they may say, ok, residential mortgages, even if things get really, really bad, we expect only a 4% NPL rate [ZC: “Non-Performing loan”] in your residential mortgage portfolio given its quality. So we give you a 8% haircut and take a little bit extra there for safety.

The simple formula governing how much capital we have or how much long term capital we need to have on hand is assets less haircut needs to be greater than our current liabilities. And that haircut is going to be determined by a third party lender.

If our capital is made up mainly of current liabilities, we need to be very conservative with what we're doing. But if your bank is capitalized using more long term capital, you can be a lot more creative with what you're doing.

So you pre-position those assets with the third-party lender or central bank and you're able to borrow against those assets at any time at whatever the asset less haircut value is, that's the effective liquid asset value. So at any point in time we have access to an amount of capital that is greater than our current liabilities, however much that is.

Basically it’s forced collateralization of all our assets in exchange for a line of credit that is greater than our current liabilities.

And that's the very, very simple description of it.

ZC: Simple!

*laughter*

DeFi, NFTs, and DAOs

ZC: You've mentioned ledgers and APIs. But when I go to your site I find no mention of DeFi.

SP: I’m skeptical of most current DeFi projects.

At the moment when you're looking at most DeFi projects, they are essentially financing forex speculation. This is extremely high risk lending, hence the high interest rates. That's not really a business that we’re all that interested in.

ZC: It's risky because if I deposit, say, Bitcoin in a DeFi platform it's going to someone who's taking some highly risky position somewhere in Crypto-land, right?

SP: Exactly, exactly. A lot of these DeFi projects have various risk mitigation strategies. So DAI for instance may be the oldest DeFi project. Not sure offhand if it is, but it’s one of the oldest at least.

DAI is an overcollateralized stable coin. So you deposit $150 worth of Ethereum and you get back $100 worth of DAI. This is the general concept. DAI is a bit different now with how it handles risk, they have more diverse but still heavily correlated collateral. Anyway the core problem is the underlying collateral is still extremely risky.

If there are any dramatic downturns in the value of that collateral, well, now all of a sudden, there's not much backing the contract. If the price of Ethereum collapses and now you seize the Ethereum in the underlying contract that’s actually backing the overcollateralized loan and you sell that off for dollars now you're pushing the price down even further.

It's not a very virtuous cycle.

ZC: Would you describe NFTs as unproductive speculation?

SP: I actually think that NFTs are more interesting than DeFi but not in the way that they’re currently being used. A lot of the NFT projects right now are just hyperlinking to a piece of art saying I purchased this piece of artwork.

Might be useful for cross-game assets or something like that. I haven’t heard of any projects doing that right now but it's not like I’ve looked very hard for that either.

ZC: Right. I'm open-minded about the big picture of NFTs but some of this stuff is terrifying, especially if you've ever worked in web development. You know how brittle startup technology can be.

The fundamental NFT concept may be sound, but the idea that you would pay thousands for a URL hosted by a random startup is... surprising.

SP: I read about a mezcal farm in Mexico that issued NFTs.

The NFT would entitle you to a unique one-of-a-kind bottle of tequila once the plants matured in seven years. Let's say you buy that bottle that appears seven years in the future. But in a few years you're a little bit tight on money.

Well, now you can sell that claim to someone else. You don't need to talk to the Tequila farm and tell them that you sold it. It's very easy, it's all registered there on chain and it's a credible claim— a credible record showing that this person has a claim on this asset.

I think that is a lot more interesting and it's something there wasn’t really a good equivalent to pre-NFTs.

ZC: I agree with you. There’s something interesting in the NFT and DAO world about marshaling capital around niche interests like a Mezcal farm. Or, as some pioneers in the Startup Cities space are doing, using these technologies to purchase land or co-working spaces or other elements that might go into a new community.

But that's a very different conversation than reinventing the whole government using a DAO. It's a different sense of the scale and scope of the innovation that will come out of it.

SP: Well, if the promises that are made with regards to Ethereum 2.0 come true with ZK rollups and super-low transaction costs and all of the other things... if those promises come true, I think it shows quite a bit of promise.

It reduces transaction costs for a massive, massive category of goods and I think that that in general would just make the market for everything much more efficient.

I'm not really too enamored with DAOs though. Mostly because voting on everything is not a good way of running an organization. I'm sure some of them will come up with different organizing mechanisms. We'll see further down the line how they evolve. I'm not too interested in them right now, but something might pop up in that space.

The Geopolitical Risk of Honduras

ZC: Recent elections in Honduras have a lot of people concerned about the long term the stability of the ZEDEs.

Surely a bank is one of the businesses that's most susceptible to geopolitical risk because capital is flighty. Are you worried?

SP: I’m not really worried about it. One thing you can see from the incoming administration is that the second they actually won the election they moderated what they were saying.

The expectation that we have from speaking with quite a few people in Tegucigalpa – investors, businessmen, various oligarchs, all of that – is that they [ZC: the winning party Libre] is going to be looking for a win against the ZEDEs. They'll get some minor reform to create a win and move on to the next issue.

The incoming administration failed to secure even a simple majority in Congress when they need a two-thirds majority to do anything against the ZEDEs. We also have various treaties backing us up. They can’t make any moves against the ZEDEs without exposing the Honduran government to substantial liability.

The business community is backing the ZEDEs. I really don't think that they're going to make any serious moves. I would be shocked if they did, in part, because they simply don't have the votes and in part because it would be disastrous for Honduras. Not that many people in the business community and not that many of the relevant figures in government would support that kind of move.

ZC: How has it been to live in Prospera?

SP: I like it quite a bit. I mean, you know, very, very good weather.

ZC: You're not smoldering in tropical heat every day?

*laughter*

SP: I like it here: 70-90 year round, right in that range. It's perfect weather.

ZC: You have an epic reading list on your site. It's really wide ranging and interesting. But, hey, it's 2022. Why bother reading books?

SP: Because they haven't made shows about it all yet.

*laughter*

SP: No but the non-snarky answer is basically, it's just a habit at this point. There's a lot of information that's out there. I like reading, I always have, I read primarily history. I just finished up reading The House of Hemp and Butter, which is a really good history of Riga in the Eastern Baltic.

ZC: That's the capital of Latvia, right?

SP: Yep.

But before the Russians conquered it in the early 1700s, it was the largest city in the Baltic. It was larger than Stockholm, larger than any of the Russian cities on it.

It was the main trading port in the Eastern Baltic. Originally founded as a crusader state during the northern crusades, it became a Hanseatic city, with a massive German merchant community there.

Why Mars Sucks

ZC: You're the CEO of a new Startup City. You raised a $15 million seed round. Nothing is built. There are no customers. What are the first things that you do? What's your strategy? Where do you build?

SP: $15 million dollars isn't going to get you that much land...

ZC: That's right. That's the point.

SP: Do you have any agreements with any host countries for any kind of political or commercial autonomy?

ZC: No.

SP: Then it becomes a lot more difficult. Those agreements take a long, long time to put in place. Assuming my investors have a relatively short time horizon -- I would actually say the best way of doing it would probably be to focus on being a real estate developer on the edges of extraordinarily expensive real estate here in the United States.

So you’d work with an open-minded local government in, say, Yonkers, New York. No idea how open-minded they actually are, just using them as an example. Now $15 million isn't gonna go very far.

But you can use the $15 million in equity plus however much you can raise in capital from banks to just start building up apartment complexes up there. Find old units and knock them down, build up apartment complexes and just try to dramatically increase density in those areas.

ZC: Let's say you had no constraints. Through some act of God you were able to get permission to build whatever you wanted at, say, a ZEDE level of autonomy, anywhere on Earth.

SP: I would probably focus on India/South Asia as a whole because of low degrees of urbanization and lots of population movement.

India in particular still has a lot of laws that are not conducive to good development. I think it would not be difficult to get a lot of Indian merchants and Indian manufacturers, traders, businessmen, etcetera, to start setting up factories in your city if they could avoid bad governance. In particular if you set it up close to a major port or on the road to a major port.

Latin America in general has reasonably high degrees of urbanization already. But there are some countries where that is still not the case.

Honduras has a fairly large rural population. Honduras works well if you're looking to bring people into the cities and increase income. Honduras also has a fairly high degree of outmigration, making it attractive for this kind of thing as well.

If you had this miraculous set of circumstances come together then I would set something up in one of these places. And if you had infinite money then I would set something up off-world.

ZC: Yeah it'll be interesting to see what the arbitration center looks like on the Mars Colony.

*laughter*

SP: Well I don't even think Mars is going to be that great of a place. It won't be the ultimate off-planet colonization destination. There are a lot of issues with it.

ZC: Like what?

SP: Well for starters one-third G. We don't know if it causes problems for humans but we certainly suspect it will. It's just enough to make getting out of the gravity well a pain.

The Martian atmosphere is thin enough to cause problems on entry but not thick enough to really slow you down. If I'm looking at space colonization I would say you're probably going to be looking at orbital habitats.

You get lower transportation costs, infinite free energy from the sun. It's easier to get back and forth to Earth. Seems like that would be the one that would make the most sense. But obviously there's a lot of development that needs to happen before any of that can become a reality.

ZC: Well that escalated quickly. I love ending on a high note like orbital habitats! Have you read SevenEves by any chance?

SP: I have. I loved the first two thirds of it.

ZC: Yeah, that's true. The ending was a bit of a letdown wasn't it?

SP: Well towards the end he kind of went off on the Lord of the Rings Quest thing a little bit. I thought that the first two thirds were really, really great. Really, really creative.

ZC: Thanks Sean!

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See you next week and don’t forget: Startups Should Build Cities!