With extreme positions on both sides, some would like to believe that decentralized technology and regulation are mutually exclusive. As ubiquitous as this narrative has become, a more developed view is that both decentralization and regulation are inevitable, so the best results are achieved when regulators and innovators come together. But what should this collaboration look like?
At the Stellar Development Foundation, we believe that regulators and innovators will (and should) influence each other, and that means that both sides should be willing to compromise. Let’s start with an honest self-reflection: there is no inherent quality of blockchain or cryptocurrency that deserves to be completely unregulated, but on the other hand, the technology also doesn’t deserve to be banned or unfairly regulated just because it’s new or different.
The Financial Action Task Force
Distributed ledger technology is a paradigm shift. Traditional finance is vertical and mediated, while decentralized finance (DeFi) is flat and peer-to-peer (P2P). The problem we are facing now is that financial rules are almost uniformly based on regulating intermediaries – no intermediary means no jurisdiction. It is this lack of clear jurisdiction that makes regulators nervous about a decentralized future. The Financial Action Task Force (FATF) expressly acknowledged this concern in its most recent draft guideline on virtual assets and VASPs:
“In addition, the full maturity of these protocols enabling P2P transactions could anticipate a future without financial intermediaries and potentially call into question the effectiveness of the FATF recommendations.”
However, as mentioned earlier, fears of a loss of market share or shrinking scope for regulation with regard to the draft FATF guidelines do not form the basis for sound political decision-making.
Connected: The FATF draft guide aims to achieve DeFi compliance
Often the fears that follow a paradigm shift lead to a regulatory crackdown. Risk reduction is a prime example. As regulators tighten anti-money laundering regulations, companies are responding by stopping service for less profitable customers. As a result, regulatory and business interests are served, but increasing numbers of individuals, especially the world’s poor and companies that serve them, are being locked out of the financial system. The FATF recently recognized its role in perpetuating this pernicious problem. But those who have been pushed out of the financial system by regulation are the very people that blockchain technology empowers most by reducing their reliance on intermediaries. At the Stellar Development Foundation, we see this firsthand through our collaboration with partners like Leaf Global and Tala, who provide blockchain-based access to financial services for the working poor and migrants fleeing disaster or persecution in their home countries.
Despite these advantages, reactions to the blockchain at the country level have been mixed. Where countries like India, Turkey and Nigeria saw fear, others like Singapore, Switzerland, Bermuda, Ukraine – and now El Salvador – saw the opportunity and developed new regulatory frameworks that take into account the decentralized nature of the blockchain. And they reap the rewards. These nations are becoming global hubs for blockchain technologies.
Innovators and entrepreneurs are drawn to their safe and stable regulatory environment. While calls for regulatory action against cryptocurrencies are growing louder in the United States and the European Union, the countries listed above are jumping ahead.
The US and other advanced economies, particularly in the West, are rapidly approaching a turning point. The decision that lies ahead of us is no longer whether to regulate, but how. Fortunately, policymakers don’t have to decide in a vacuum and would do well to learn from the two groups of countries mentioned above – those who try to keep crypto out and those who embrace it. Without exception, those countries that have proactively tailored their regulators to the technology have been more successful than those who tried to ban it. Even if it is not too late for the US to follow the successful examples, it must nonetheless choose to do so.
The self-hosted wallet rule proposed by the Financial Crimes Enforcement Network (FinCEN) provides a useful case study of this choice. From the beginning, FinCEN’s proposal was opposed to decentralization and individual empowerment. While it wouldn’t specifically prohibit self-hosted wallets, many believe it would in practice. However, the blockchain community reacted strongly and delivered a record number of comments in a very short time. One of the issues that emerged from these comments was that, due to the inherent transparency of public blockchains, FinCEN already had access to most of the information sought in the proposal. FinCEN appears to have listened and will seek further collaboration with those who know the technology best.
While we have to wait and see how the story ends, it now appears that FinCEN is taking the collaborative approach with industry that is envisaged – but not always practiced – by the rulemaking process. Compromises are not easy, but they produce the best results.
Connected: Authorities are trying to close the gap in non-hosted wallets
The job of regulators is to protect markets, not to ensure that they never change. Policy makers should accept that decentralization is a new, different paradigm that deserves its own regulatory approach. The industry’s resistance to date is not so much directed against the idea of regulation, but rather against being forced into an unsuitable regulatory framework. Even so, regulators and innovators can strike a middle ground, but only if both sides are open-minded.
Likewise, the blockchain community needs to better explain why and how technology differs, educate policy makers about the real risks, while highlighting real examples of its benefits. In addition, we should adopt appropriately tailored regulation.
Finally, the legitimacy that would result from regulatory acceptance of the technology could be the final hurdle on the road to mass adoption.
The views, thoughts, and opinions expressed herein are those of the author alone and do not necessarily reflect the views and opinions of Cointelegraph.
Seth Hertlein is the director of policy and government relations for the Stellar Development Foundation, a non-profit that supports the development and growth of Stellar, an open source network that connects the world’s financial infrastructure. Seth began his career as a securities regulator, most recently as Executive Director and Assistant General Counsel for Public Policy and Regulatory Affairs at FS Investments, a leading alternative asset manager. Seth holds an MBA in Finance from Wright State University and a JD from Ohio State University.