This list of agency actions will hopefully help U.S. regulators take steps in the right direction.

By Brian Quintenz, Director of Policy at a16z

Compiled by: Luffy, Foresight News

It can be challenging for a government to develop effective policies for emerging technologies, especially when the technology does not fit into traditional regulatory frameworks. This is the case with Web3, as decentralized systems are inherently unable to comply with traditional legal requirements. For example, current rules assume the existence of some kind of centralized intermediary, which is typically absent in Web3. These rules are intended to reduce risks such as conflicts of interest and information asymmetry that arise from the presence of trusted centralized entities such as management teams; however, applying such rules to decentralized systems may force the system to re-centralize, hinder innovation, undermine the transformative potential of Web3, and harm user interests.

Decentralization has reshaped fields such as social media, identity management, creative industries, and finance. Although the United States is the developed country with the highest cryptocurrency adoption rate, it does not have an effective regulatory system for decentralized crypto assets.

While the US has made some progress (like FIT21 and Wyoming’s DUNA), we still need significant legislative progress to provide regulatory clarity, properly incentivize decentralization, and protect consumers. Regardless of who wins the US election, there are simple steps (without legislation) that government departments and agencies can take to help the US seize the Web3 opportunity.

Here are seven of the most important. While this list is not comprehensive, it should help the U.S. government and other stakeholders understand how to move in the right direction.

1. All relevant departments should include promoting competition and innovation within their responsibilities

As Marc Andreessen and Ben Horowitz have argued, the key to America’s tech hegemony has always been the startup. “A startup is a courageous group of outcasts and misfits who come together with a dream, ambition, courage, and a special set of skills to create something new for the world, to build a product that improves people’s lives and to start a company that might go on to create more new things in the future,” they observed. Edison, Jobs, and Musk represent just a few of America’s startup leaders. America’s leadership in startups is due in large part to competitive innovation generated by our pioneering spirit, work ethic, rule of law, strong capital markets, education system, and public sector investment in R&D.

Although startups can redefine old industries and, in some cases, even create new ones, they face a variety of possible disadvantages from the outset. Startups often have a harder time getting off the ground than larger companies with large user bases and financial resources. Some established companies may have another advantage: the ability to get governments to fight startup competitors or impose expensive rules that create "regulatory barriers to entry."

If startups are the lifeblood of innovation in the United States, then all agencies should include promoting competition and innovation in their responsibilities, ensuring these goals are their top priorities.

2. The SEC should engage in formal rulemaking and provide clear guidance on the classification of digital asset transactions

When the staff of the U.S. Securities and Exchange Commission (SEC) has trouble defining which crypto asset transactions are securities, imagine how difficult it is for the average user. Due to this lack of clarity, there is no functioning digital asset market in the United States. To address this issue, the SEC should engage in rulemaking to provide clear instructions to market participants on whether a transaction in a particular digital asset involves the sale of a security, an action that would have many implications. But since 2019, the SEC has resisted calls to issue guidance to the public, instead opting for counterproductive regulation through enforcement that could harm businesses, confuse investors, and disrupt everyday users.

3. Eliminate intermediary requirements. Blockchain eliminates the need for a third party

One of the key innovations of blockchain is the ability to conduct transactions without the need for a third-party centralized intermediary. However, the current rules designed for traditional markets presuppose the existence of centralized intermediaries such as brokers, clearing houses, custodians, and market makers.

Regulation is appropriate when centralized firms are involved in these functions. But treating decentralized systems in the same way prevents them from playing similar roles and insulates them from the benefits these systems provide. This amounts to a form of “technological discrimination.” Disintermediating services can reduce risks (such as counterparty risk) and costs (such as transaction fees) while increasing efficiency and promoting competition. If blockchain technology eliminates the need for intermediaries, regulators should remove intermediary requirements where relevant.

Similarly, by updating existing rules, institutions can help blockchain revolutionize our financial system. Cross-border payments, settlement of digital securities and commodity trades, and derivatives markets could all become more efficient if existing rules were adapted to transactions on the blockchain.

4. Improve transparency in agency decision-making processes and strengthen communication with private sector stakeholders, civil society organizations, academia, and the public

Improving transparency into institutional decision-making processes is critical to developing sound crypto policy. It builds trust, ensures accountability, and allows for public participation. Open dialogue with stakeholders ultimately leads to more effective regulatory solutions: firms work with regulators to explore these solutions, ensuring that regulators fully understand dynamic market structures and the firms’ objectives, operations, and risks. When institutions openly share how they make decisions, it also prevents undue influence from special interests and helps ensure policy is fair.

It is critical that agencies encourage (or at least allow) businesses to hold educational meetings with regulators without fear of retaliation from enforcement actions. This will help achieve what I call “regulation through dialogue,” rather than regulation through enforcement.

Transparency enables stakeholders, including innovators and the public, to provide feedback, thereby promoting a smarter, more inclusive approach to crypto regulation.

5. Allow White House staff and federal agency employees to use cryptocurrency

A 2022 legal advisory notice issued by the U.S. Office of Government Ethics prohibits “employees who hold cryptocurrencies or stablecoins” from participating in the development of cryptocurrency-related policies and regulations that could affect the value of their assets. The notice applies to all White House staff and federal agency employees and stipulates that the de minimis thresholds applicable to securities do not apply to cryptocurrencies.

Maintaining ethical standards regarding conflicts of interest is certainly important for building trust in government actions. But preventing government employees responsible for writing cryptocurrency rules from using cryptocurrencies is like banning Department of Transportation officials from riding trains or planes. Government employees responsible for regulating cryptocurrencies should be allowed to use cryptocurrencies.

6. Provide specialized training for government employees

In addition to benefiting from their interactions with cryptocurrencies, government employees will also benefit from specialized blockchain knowledge training. This is critical to understanding decentralized innovation, informed policy decisions, and effective use of law enforcement resources. As decentralized systems reshape areas such as finance and cybersecurity, officials need to understand key concepts such as blockchain analysis, smart contract design, and decentralized governance. This training can help officials understand how to leverage the transparency of blockchain to better achieve regulatory goals. It will also help governments develop fair regulations, support blockchain-driven innovation, and ensure that public sector initiatives are aligned with the principles of decentralization and the public interest.

Partnerships are one option. By working with industry, research institutions, and universities, governments can provide their staff with cutting-edge research and expertise in blockchain technology. Where such initiatives already exist (such as the SEC’s Strategic Center for Innovation and Financial Technology), agencies should leverage collaborations with innovators, developers, and builders of new technologies.

7. Support private sector blockchain research and use zero-knowledge proofs to better protect sensitive and proprietary information

U.S. government agencies should also promote research into open source, permissionless blockchain systems to ensure national security. Many of our adversaries, including Russia and others, are developing government-backed blockchain protocols that, if adopted globally, could give hostile governments access to personally identifiable information and sensitive financial and operational data. U.S. agencies should support blockchain research to help develop private sector solutions that can help the United States address the risk of losing the crypto space to other countries that do not share Western values.

One area where governments could benefit from R&D is in privacy-preserving technologies such as zero-knowledge proofs (ZKPs). ZKPs represent a significant improvement in privacy technology compared to other privacy-enhancing technologies, ensuring users receive maximum privacy and control.

ZKP can directly benefit U.S. government agencies by helping them enhance information security and privacy. Blockchain provides a decentralized, secure ledger that ensures data is protected across multiple nodes. Encrypting and decentralizing information reduces the risk of hacker attacks and service disruptions. ZKP allows parties to verify the authenticity of information without revealing the actual data, allowing only necessary proof of identity or authorization to be shared without exposing sensitive details. For example, proving that someone is over a certain age threshold without revealing their date of birth.

Blockchain and zero-knowledge proofs combined can enhance data integrity, increase trust in digital systems, and protect confidential information across various government operations. Agencies can also use decentralized systems to improve data transmission, communications, and more. Therefore, agencies should consider using blockchain and zero-knowledge proofs to protect sensitive information and improve efficiency.

Summarize

The United States needs to do more to establish an effective crypto regulatory regime, one that both incentivizes decentralization and protects consumers. In the meantime, we hope this list of agency actions helps U.S. agencies and other stakeholders understand how to take steps in the right direction without waiting for new legislation. Perhaps, while we wait for legislation, workers may be allowed to actually adopt cryptocurrencies.