Author: Brian Quintenz, a16z Policy Director
Compiled by: Luffy, Foresight News
For a government, formulating effective policies for emerging technologies can be challenging, especially when such technologies do not fit traditional regulatory frameworks. The case of Web3 is a prime example, as decentralized systems are inherently unable to comply with conventional legal requirements. Current rules assume the existence of some centralized intermediary, whereas there are often no centralized intermediaries in Web3. These rules aim to mitigate risks arising from conflicts of interest, information asymmetry, and other issues associated with trusted centralized entities like management teams; however, applying such rules to decentralized systems may force them to re-centralize, stifle innovation, undermine the transformative potential of Web3, and harm user interests.
Decentralization has reshaped sectors such as social media, identity management, creative industries, and finance. Although the U.S. has the highest cryptocurrency adoption rate among developed countries, it lacks an effective regulatory framework for decentralized crypto assets.
While the U.S. has made some progress (such as FIT21 and Wyoming's DUNA), we still need significant legislative progress to provide regulatory clarity, appropriately incentivize decentralization, and protect consumers. Regardless of who wins the U.S. elections, government departments and agencies can take some straightforward steps (without legislation) to help America seize the Web3 opportunity.
Here are the seven most important items. While this list is not exhaustive, it should help the U.S. government and other stakeholders understand how to move in the right direction.
1. Relevant departments should incorporate the promotion of competition and innovation into their responsibilities.
As Marc Andreessen and Ben Horowitz have said, the key to America's technological dominance has always been startups. They observe: "Startups are a group of brave outcasts and misfits who come together with dreams, ambition, courage, and a special set of skills to create new things for the world, build a product that can improve people's lives, and start a company that may continue to create more new things in the future." Edison, Jobs, and Musk are just a small representation of the leaders of American startups. America's leadership in startups is largely due to our spirit of innovation, work ethic, rule of law, strong capital markets, education system, and investment in R&D by the public sector that generates competitive innovation.
Although startups can redefine old industries and, in some cases, even create new ones, they often face various potential disadvantages from the outset. Compared to large companies that have substantial user bases and financial resources, startups tend to struggle in their early stages. Some established companies may also have another advantage: the ability to leverage government forces against startup competitors or to impose costly regulations that create "regulatory entry barriers."
If startups are the lifeblood of American innovation, then all agencies should incorporate the promotion of competition and innovation into their responsibilities, ensuring that these goals become their top priorities.
2. The SEC should engage in formal rule-making and provide clear guidance on the classification of digital asset transactions.
Imagine how difficult it is for ordinary users when even the staff of the SEC struggles to define which cryptocurrency transactions fall under securities. Due to a lack of clarity, the U.S. lacks a properly functioning digital asset market. To address this issue, the SEC should participate in rule-making to provide clear guidance to market participants on whether specific digital asset transactions involve the sale of securities; taking this action would have numerous implications. However, since 2019, the SEC has resisted calls to issue guidance to the public, opting instead for counterproductive regulation through enforcement, which may harm businesses, confuse investors, and disrupt everyday users.
3. Eliminate intermediary requirements; blockchain eliminates the need for third parties.
A key innovation of blockchain is the ability to transact without the need for third-party centralized intermediaries. However, current rules designed for traditional markets presuppose the existence of centralized intermediaries, such as brokers, clearinghouses, custodians, and market makers.
When centralized companies engage in these functions, regulation is appropriate. However, treating decentralized systems in the same manner would hinder them from performing similar roles and cut off the benefits these systems provide. This is akin to a form of "technological discrimination." Removing intermediaries 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 eliminate intermediary requirements in relevant contexts.
Similarly, by updating existing rules, agencies can help blockchain fundamentally reshape our financial system. If existing rules can adapt to transactions on blockchain, then cross-border payments, digital securities and commodity trading settlements, and derivatives markets can become significantly more efficient.
4. Increase transparency in agency decision-making processes and strengthen communication with private sector stakeholders, civil society organizations, academia, and the public.
Increasing transparency in agency decision-making processes is vital for formulating sound crypto policies. It can build trust, ensure accountability, and allow public participation. Open dialogue with stakeholders ultimately leads to more effective regulatory solutions: businesses and regulators collaborate to explore these solutions to ensure that regulators fully understand the dynamic market structures, as well as the goals, operations, and risks of businesses. When agencies openly share how decisions are made, it can also prevent undue influence from special interests and help ensure policies are fair.
It is crucial that agencies encourage (or at least allow) businesses to hold educational meetings with regulators without fearing retaliation from enforcement actions. This will help achieve what I call "regulation through dialogue," rather than regulation through enforcement.
Transparency allows stakeholders (including innovators and the public) to provide feedback, thereby facilitating a more informed and inclusive approach to crypto regulation.
5. Allow White House staff and federal agency employees to adopt cryptocurrencies.
A legal advisory notice published by the U.S. government's ethics office in 2022 prohibits "employees holding cryptocurrencies or stablecoins" from participating in the formulation of cryptocurrency-related policies and regulations that may affect the value of their assets. This notice applies to all White House staff and federal agency employees and stipulates that the minimum threshold applicable to securities does not apply to cryptocurrencies.
Maintaining ethical standards regarding conflicts of interest is certainly important for building trust in government actions. However, preventing government employees responsible for formulating cryptocurrency regulations from using cryptocurrencies is akin to forbidding transportation department 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 benefitting from interaction with cryptocurrencies, government employees will also benefit from specialized blockchain knowledge training. This is crucial for understanding decentralized innovations, making informed policy decisions, and effectively utilizing enforcement resources. As decentralized systems reshape sectors 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 blockchain's transparency to better achieve regulatory goals. It will also help the government create fair regulations that support blockchain-driven innovation and ensure that public sector initiatives align with the principles of decentralization and the public interest.
Partnerships are a good option. By collaborating with industry, research institutions, and universities, the government can provide employees with cutting-edge research and expertise in blockchain technology. If such initiatives already exist (like the SEC's Strategic Hub for Innovation and Financial Technology), agencies should leverage collaboration with innovators, developers, and builders of new technologies.
7. Support private sector blockchain research and utilize zero-knowledge proofs to better protect sensitive and proprietary information.
U.S. government agencies should also promote research on 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 enable hostile governments to acquire personal identity information and sensitive financial and operational data. U.S. agencies should support blockchain research to help develop private sector solutions that can assist America in addressing the risks of losing in the crypto space to countries that do not share Western values.
One area where the government can benefit from R&D is privacy-preserving technologies, such as zero-knowledge proofs (ZKP). Compared to other privacy-enhancing technologies, ZKP represents a significant improvement in privacy technology, ensuring users achieve maximum privacy and control.
ZKPs 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. Encryption and decentralized information can reduce the risks of hacking and service disruptions. ZKPs allow parties to verify the authenticity of information without revealing the actual data, enabling only necessary identity or authorization proofs to be shared without exposing sensitive details. For example, proving that someone's age exceeds a certain threshold without disclosing their date of birth.
The combination of blockchain and zero-knowledge proofs can enhance data integrity, increase trust in digital systems, and protect confidential information in various government operations. Agencies can also use decentralized systems to improve data transmission, communication, and more. Therefore, agencies should consider using blockchain and zero-knowledge proofs to protect sensitive information and improve efficiency.
Summary
The U.S. needs to do more work to establish an effective cryptocurrency regulatory framework that incentivizes decentralization while protecting consumers. Meanwhile, we hope this agency action checklist can help 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, staff may be allowed to actually adopt cryptocurrencies.