Original Author: Brian Quintenz, Policy Director at a16z
Original Source: Foresight News
Reprinted: Koala, Mars Finance
For a government, crafting effective policies for emerging technologies can be challenging, especially when the technology does not fit traditional regulatory frameworks. The case of Web3 is such, as decentralized systems inherently cannot comply with traditional legal requirements. For instance, current rules assume the presence of some centralized intermediary, while Web3 often lacks such intermediaries. These rules aim to mitigate risks arising from conflicts of interest and information asymmetries associated with trusted centralized entities like management teams; however, applying such rules to decentralized systems could force the systems to re-centralize, stifling innovation, undermining the transformative potential of Web3, and harming user interests.
Decentralization has reshaped areas 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 decentralized crypto asset regulatory framework.
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 simple steps (without legislation) to help the U.S. seize the Web3 opportunity.
Here are the seven most important ones. 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 stated, the key to America's tech dominance has always been startups. They observe: "Startups are a group of brave outcasts and misfits coming together with dreams, ambitions, courage, and a special set of skills to create something new 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 leading position in startups is largely due to our pioneering spirit, work ethic, rule of law, strong capital markets, educational system, and competitive innovation generated by public sector investment in R&D.
Although startups can redefine old industries and in some cases even create new ones, they face various potential disadvantages from the outset. Compared to large corporations with vast user bases and financial resources, startups often struggle to get off the ground. Some established companies may also have another advantage: the ability to leverage the government to compete against startup rivals or implement costly regulations, thus 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, ensuring these goals become their top priority.
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 U.S. Securities and Exchange Commission (SEC) struggle to define which cryptocurrency transactions qualify as securities. Due to the lack of clarity, there is no properly functioning digital asset market in the U.S. To address this issue, the SEC should engage in rule-making to provide clear guidance to market participants to understand whether the trading of specific digital assets involves the sale of securities; taking this action would have many implications. However, since 2019, the SEC has resisted calls to issue guidance to the public, instead opting for counterproductive regulation through enforcement, which may harm businesses, confuse investors, and disrupt everyday users.
3. Eliminate intermediary requirements; blockchain removes the need for third parties.
A key innovation of blockchain is the ability to transact without 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 enterprises engage in these functions, regulation is appropriate. However, treating decentralized systems in the same way would hinder their ability to serve similar roles and isolate the benefits they offer. This amounts to a form of "technology discrimination." Disintermediation can reduce risks (such as counterparty risk) and costs (such as transaction fees), while increasing efficiency and fostering 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 could adapt to transactions on blockchain, then cross-border payments, digital securities and commodities trading settlement, and derivatives markets could become much more efficient.
4. Improve the transparency of institutional decision-making processes and strengthen communication with private sector stakeholders, civil society organizations, academia, and the public.
Enhancing the transparency of institutional decision-making processes is crucial for developing sound crypto policies. It can build trust, ensure accountability, and allow public participation. Open dialogues with stakeholders will ultimately lead to more effective regulatory solutions: businesses collaborating with regulators to explore these solutions, ensuring that regulators fully understand dynamic market structures as well as the goals, operations, and risks of businesses. When institutions 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 refer to as "regulating through dialogue" rather than through enforcement.
Transparency enables stakeholders (including innovators and the public) to provide feedback, thereby fostering 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 who hold 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 specifies 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. But preventing government employees responsible for creating cryptocurrency rules from using cryptocurrencies is akin to prohibiting transportation department officials from taking 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 interactions with cryptocurrencies, government employees will also benefit from specialized blockchain knowledge training. This is critical for understanding decentralized innovation, 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 analytics, smart contract design, and decentralized governance. This training can help officials learn how to leverage the transparency of blockchain to better achieve regulatory goals. It will also assist the government in formulating fair regulations, supporting blockchain-driven innovation, and ensuring public sector initiatives align with the principles of decentralization and 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 on blockchain technology. If such initiatives already exist (such as 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, if adopted globally, could allow hostile governments to obtain personal identification information and sensitive financial and operational data. U.S. agencies should support blockchain research to help develop private sector solutions that can help the U.S. mitigate the risks of losing in the crypto space to other countries that do not share Western values.
One area where the government can benefit from R&D is privacy protection technology, such as zero-knowledge proofs (ZKPs). Compared to other privacy-enhancing technologies, ZKPs represent a significant improvement 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, ensuring that data is protected across multiple nodes. Encryption and decentralized information can reduce the risks of hacking and service interruptions. ZKPs allow parties to verify the authenticity of information without disclosing actual data, making it possible to share only necessary identification or authorization proof 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 transfer, communication, and more. Therefore, agencies should consider employing blockchain and zero-knowledge proofs to protect sensitive information and improve efficiency.
Summary
The U.S. needs to do more to establish an effective crypto regulatory framework, one that incentivizes decentralization while protecting consumers. Meanwhile, we hope this list of agency actions 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 await legislation, staff may be allowed to actually adopt cryptocurrencies.