By Brian Quintenz, Global Head of Policy at a16z Crypto and former Commissioner of the Commodity Futures Trading Commission (CFTC);
Developing effective policies for emerging technologies can be challenging, especially when the technology does not fit into traditional regulatory frameworks. This is certainly 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 often not the case in Web3. These rules are designed to reduce risks such as conflicts of interest and information asymmetry that arise from the presence of trusted intermediaries such as management teams. However, applying such rules to decentralized systems could force the system to be re-centralized, hinder innovation, undermine the transformative potential of Web3, and harm the interests of users.
Decentralization has reshaped areas such as social media, identity management, creative industries, and finance. But despite being the developed country with the highest cryptocurrency adoption rate, the United States does not have an effective regulatory system for decentralized crypto assets.
While the United States has made some progress (such as FIT21 and Wyoming's DUNA), we still need significant legislative progress to provide regulatory clarity, properly encourage decentralization, and protect consumers. Regardless of who wins the US election, there are some simple steps (without legislation) that US government departments and agencies can take today to help the United States seize the Web3 opportunity.
Here are seven of the most important ones. While this list is not complete, it should help the US government and other stakeholders understand how to move in the right direction.
1. Relevant departments should include promoting competition and promoting innovation in their responsibilities
As Marc Andreessen and Ben Horowitz wrote, the key to US technological hegemony has always been start-ups (see Jinse Finance's previous report "a16z founder: American century and small technology companies"). They observed: “A startup is a courageous group of outcasts and misfits coming 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, to start a company that might go on to create more new things in the future.” Edison, Jobs, and Musk are just a few of America’s startup champions. America’s leadership in startups is largely due to competitive innovation generated by our pioneering spirit, professional ethic, rule of law, strong capital markets, education system, and public sector investment in research and development. While startups can redefine and, in some cases, even create entire industries, 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 incumbents may have another advantage: the ability to pit government against startup competitors or impose expensive rules that create “regulatory barriers to entry.”
If startups are the lifeblood of American innovation, then all agencies should include increasing competition and promoting innovation in their responsibilities to ensure that these goals remain their top priority.
2. The SEC should participate in formal rulemaking and provide clear guidance on the classification of digital asset transactions
When the staff of the US SEC has difficulty defining which crypto asset transactions are securities, imagine how difficult it is for ordinary users. Due to the lack of clarity, there is no functioning digital asset market in the United States. To address this problem, the SEC should participate in rulemaking to provide market participants with clear instructions to understand whether transactions in specific digital assets involve the sale of securities-taking this action will have many implications. But since 2019, the SEC has resisted calls to issue guidance to the public, instead choosing to conduct 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 that it can facilitate transactions without a third-party centralized intermediary. However, current rules designed for traditional markets presuppose the existence of centralized intermediaries, such as brokers, clearing houses, custodians, and market makers. When centralized firms participate in these functions, regulation is appropriate. But treating decentralized systems in the same way prevents them from playing similar roles and hinders the benefits these systems provide. This amounts to a “technologically discriminatory” approach. 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. For example, securities laws should not require intermediaries when blockchain technology can achieve the same regulatory goals. Similarly, by updating existing rules, agencies can help blockchain revolutionize our financial system. Cross-border payments, settlement of digital securities and commodity transactions, and derivatives markets can all become more efficient if existing rules can accommodate transactions on the blockchain.
4. Improve transparency in institutional decision-making processes and increase engagement with private sector stakeholders, civil society organizations, academia, and the public
Increasing transparency in institutional decision-making processes is critical to developing sound crypto policies. It builds trust, ensures accountability, and allows for public participation. Open dialogue with stakeholders ultimately leads to more effective regulatory solutions—and companies work with regulators to explore these solutions to ensure that institutions fully understand the dynamic market structure and the goals, operations, and risks of companies. When institutions openly share how they make decisions, it also prevents undue influence from special interests and helps ensure that policies are balanced and fair.
It is critical that institutions encourage (or at least allow) companies 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 that reflects different perspectives and promotes long-term growth.
5. Allow White House staff and federal agency employees to use cryptocurrencies
A legal advisory notice issued by the U.S. Office of Government Ethics in 2022 prohibits "employees who hold any amount of cryptocurrency or stablecoins" from participating in the development of crypto-related policies and regulations that may affect the value of their assets. The notice applies to all White House staff and federal agency employees and stipulates that the minimum thresholds applicable to securities do not apply to cryptocurrencies.
Maintaining ethical standards in terms of conflicts of interest is certainly critical to building trust in government actions. But preventing government employees responsible for developing cryptocurrency rules from using any amount of cryptocurrency is like prohibiting Department of Transportation officials from getting in cars or on planes. Smart policies come from participation and the knowledge it provides. Government employees responsible for regulating cryptocurrency should be allowed to use it.
6. Provide specialized training for government employees
In addition to benefiting from interacting with cryptocurrencies, government employees will also benefit from specialized blockchain training - which is essential for understanding decentralized innovation, smart 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 blockchain’s transparency to better achieve regulatory outcomes. It will also help governments develop balanced regulations that support blockchain-driven innovation and ensure that public sector initiatives are consistent with the principles of decentralization and the public interest.
Partnerships can enhance this training: By working with industry, research institutions, and universities, governments can provide employees 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 advance national security. Many of our adversaries, including Russia and China, 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 out to other countries that do not share Western values in the crypto space.
One area where government R&D could benefit is in the development of privacy-preserving technologies, such as zero-knowledge proofs (ZKPs). ZKPs represent a step-function improvement over other privacy-enhancing technologies, ensuring that users have the greatest degree of privacy and control.
ZKPs can directly benefit U.S. government agencies by helping them enhance the security and privacy of their information. 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. ZKPs allow parties to verify the authenticity of information without revealing the actual data, making it possible to share only necessary proof of identity or authorization 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 a variety of government operations. Agencies can also use decentralized systems to improve data transfer, communications, and more. Agencies should therefore consider using blockchain and zero-knowledge proofs to protect sensitive information (e.g., private sector financial data) and improve efficiency.
The United States needs to do more to establish an effective crypto regulatory regime—one that incentivizes decentralization while protecting consumers. In the meantime, we hope that this list of possible agency actions, while incomplete, 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, staff may be allowed to actually use more cryptocurrencies.
Brian
Alex
Kikyo