Written by: 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 technology does not fit traditional regulatory frameworks. Web3 is a case in point, as decentralized systems inherently cannot comply with traditional legal requirements. For example, current rules assume the presence of some centralized intermediary, whereas Web3 often lacks centralized intermediaries. These rules are designed to mitigate risks arising from conflicts of interest and information asymmetry associated with trusted centralized entities such as management teams; however, applying such rules to decentralized systems may force systems to recenter, stifle innovation, undermine Web3's transformative potential, and harm user interests.

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

While the U.S. has made some progress (like FIT21 and Wyoming's DUNA), we still need significant legislative advancements to provide regulatory clarity, appropriately encourage decentralization, and protect consumers. Regardless of who wins the U.S. elections, government departments and agencies can take some simple steps (without legislation) to help America seize Web3 opportunities.

Here are the seven most important points. 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 American tech dominance has always been startups. They observed, 'Startups are a group of brave misfits and outcasts coming together with dreams, ambition, courage, and a unique set of skills to create new things for the world, build a product that improves 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 America's startup leaders. The U.S. leading position in startups is largely due to our pioneering spirit, work ethic, rule of law, strong capital markets, education system, and competitive innovation fostered by public sector investment in R&D.

While startups can redefine old industries and even create new ones in some cases, they face various potential disadvantages from the outset. Compared to large enterprises with significant user bases and financial resources, startups often struggle from the beginning. Some established companies may also have another advantage: the ability to use government to compete against startup rivals or impose costly regulations, thereby creating '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 to ensure these goals are prioritized.

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

When the SEC's staff struggles to define which crypto asset transactions qualify as securities, imagine how difficult it is for the average user. Due to a lack of clarity, the U.S. does not have a functioning digital asset market. To address this issue, the SEC should engage in rulemaking to provide market participants with clear guidance on whether specific digital asset transactions involve the sale of securities; taking this action would have many implications. However, since 2019, the SEC has resisted calls to publicly issue guidance, opting instead for counterproductive regulation through enforcement that 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 third-party centralized intermediaries. However, the current rules designed for traditional markets presuppose the existence of centralized intermediaries, such as brokers, clearinghouses, custodians, and market makers.

Regulation is appropriate when centralized enterprises engage in these functions. However, treating decentralized systems in the same way will hinder their ability to perform similar functions and isolate the benefits that these systems provide. This amounts to a form of 'technological discrimination.' Disintermediation 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 in relevant cases.

Similarly, by updating existing rules, agencies can help blockchain fundamentally transform our financial system. If existing rules can adapt to transactions on blockchain, then cross-border payments, digital securities and commodity trade settlements, and derivatives markets can become more efficient.

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

Increasing transparency in agency decision-making processes is crucial for developing sound crypto policies. It can build trust, ensure accountability, and allow public participation. Open dialogue with stakeholders will ultimately lead to more effective regulatory solutions: businesses and regulators collaborating to explore these solutions to ensure regulators fully understand dynamic market structures and the objectives, operations, and risks of businesses. When agencies publicly share how decisions are made, it can also prevent undue influence by special interests and help ensure policies are equitable.

It is crucial that agencies encourage (or at least allow) businesses to hold educational meetings with regulators without fear of enforcement action retaliation. This will help achieve what I call 'regulation by dialogue' rather than regulation by enforcement.

Transparency allows stakeholders (including innovators and the public) to provide feedback, 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 issued by the U.S. Office of Government Ethics in 2022 prohibits 'employees holding cryptocurrencies or stablecoins' from participating in the formulation of cryptocurrency-related policies and regulations that could affect the value of their assets. This notice applies to all White House staff and federal agency employees and specifies that the minimum threshold applicable to securities does not apply to cryptocurrencies.

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

6. Provide specialized training for government employees

In addition to benefiting from interactions with cryptocurrencies, government employees will also gain from specialized training in blockchain knowledge. This is crucial for understanding decentralized innovations, making informed policy decisions, and effectively utilizing enforcement resources. As decentralized systems reshape fields 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 assist governments in formulating fair regulations, supporting blockchain-driven innovations, and ensuring public sector initiatives align with principles of decentralization and public interest.

Partnerships are a good option. By collaborating with industry, research institutions, and universities, the government can provide its 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 partnerships 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, are developing government-supported blockchain protocols that could give hostile governments access to personal identification information as well as sensitive financial and operational data if adopted globally. U.S. agencies should support blockchain research to help develop solutions in the private sector that can help America mitigate the risks of losing to countries that do not share Western values in the crypto space.

One area where the government can benefit from R&D is privacy-enhancing technologies, such as zero-knowledge proofs (ZKP). Compared to other privacy-enhancing technologies, ZKP represents a significant advancement in privacy technology, ensuring users have 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 risk of hacking and service interruptions. ZKPs allow parties to verify the authenticity of information without disclosing the actual data, enabling them to share only necessary identity or authorization proofs without exposing sensitive details. For example, proving that someone is over a certain age without revealing their birth date.

The combination of blockchain and zero-knowledge proofs can enhance data integrity, improve 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 increase efficiency.

Summary

The U.S. needs to do more to establish an effective cryptocurrency regulatory framework that incentivizes decentralization while protecting consumers. At the same time, we hope this agency action checklist helps U.S. agencies and other stakeholders understand how to take steps in the right direction without waiting for new legislation. Perhaps while we await legislation, staff may be allowed to actually adopt cryptocurrencies.