Crypto needs Governance, but not Governments

The problem: After years of operating fully unregulated, governments around the world are now trying to impose their legislative powers on the cyptoeconomy. Such regulations may include heavy legal restrictions on how cryptocurrencies and tokens are allowed to operate, up to state monopolies and outright bans on their usage. Additionally, in the past, several lawsuits have been raised against cryptocurrency enterprises in the wake of fraud, hacks, etc., which poses a problem to lawmakers and judges, as they are unable to keep up with the developments in the cryptosphere. In the context of this, I would like to put two axioms up for discussion. 

Axiom 1: Any attempts by the state to regulate crypto will inevitably lead to a negative outcome.  Most lawmakers do not have any experience in the cryptosphere, and typically, lawmakers tend to fear what they don't understand. This fear is in part justified, as their control over decentralized blockchains and applications is severely limited, but this poses the danger that governments will overregulate the cryptosphere to the point where the whole economy breaks down. In countries where crypto usage is banned, investors and traders might furthermore be prosecuted by law. Especially the lawsuits that have been raised in the context of the cryptoeconomy increase the risk that legislators may pass overly strict regulations in order to make disputes easier to handle.  

Even if we wholeheartedly assume a competent and benevolent government, economic regulations rarely lead to a net benefit, especially in areas that are not run by large corporations, but by entrepreneurs and enthusiasts. Whenever an economic sector gets regulated, more market entry barriers are being put into place, as the bureaucratic and legal effort to comply with all regulations rises. This generally stifles innovation and competition in the market. Examples of this can be found in the telecommunications sector, where the FCC delayed the introduction of mobile phone services by 10 years, or in the early days of the commercialized Internet, where only after governments switched from monopolistic policies towards competition in the market, private ISPs were allowed to compete for higher bandwidths at lower prices.  

Axiom 2: Any regulation that leads to a positive outcome can be achieved by private law  Needless to say, there are certain regulations that have a positive impact on the economy, like consumer protection. For example, on the field of telecommunications, the point can be made that open access regulations, which prevent ISPs from shutting smaller providers out of their network, can in fact increase the level of competition. The same argument is often brought forward in support of net neutrality, as its abolishment could lead to higher market entry barriers for small web projects (e.g. emerging social networks), which are in competition with established companies who can afford to pay providers for higher connection speeds. 

Since, assuming that this is in fact the case, such regulations do have a net benefit, it is theoretically possible for all of them to come about in the form of private agreements instead of governmental intervention. For this to work out however, these benefits must be shared in such a way that no stakeholder is left worse off by voluntarily agreeing to the regulation. 

Proposed solution: In order to mitigate the threat of regulation, the cryptoeconomy must demonstrate that it is able to govern itself. A possible way to achieve this is to establish an authority that grants certificates to crypto projects that voluntarily agree to a certain set of regulations. The model such an authority operates on would be similar to the UTZ certificate that guarantees for certain products (coffee, cocoa, etc.) that they have been produced sustainably, or the Fairtrade label that guarantees a minimum price to producers. While such certificates increase the production costs, it allows for such products to be placed on the ethical consumer market, which offsets the higher production costs and can thus even increase a company's profit. This allows those companies to voluntarily produce their goods under the standards set by the certificate.

Likewise in the context of crypto, such certificates could increase trust in a project, leading to higher investments and higher gains in token value. Certificates should come in different varieties that deal with AML/KYC laws, data protection, other existing national regulations, or even the obligation to appeal a certain arbitrating body in the case of disputes. In the current absence of arbitrators that specialize in the cryptoeconomy, the next logical step would be to establish such a court of arbitration, with the ability to retract certificates, if a project acts in noncompliance, thus enforcing the court's orders. Furthermore, regular auditing of certificate holders is necessary to ensure that they are compliant to their certified standards. In order to prevent misuse of certificates, a public blockchain should be kept that records all certificates that have been granted or retracted.

It is still an open question, how such a certification authority, with its auditing and arbitrating bodies should be funded. Possibly the easiest solution would be to conduct a token sale and have certificate holders pay for auditing and arbitration in these tokens, but this poses a series of other problems, as the certification authority needs to secure enough continuous funding for a prolonged operation, while providing a steady value growth for investors, without leading to excessive costs for certificate holders and applicants. Therefore, comments on potential funding and business models are requested.  

 

Authorship information: Position paper for the 2018 Computational Law & Blockchain Festival by  Tobias W. Kaiser, [email protected]