Innovation and Regulation — A Timeless Dance
(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
Regulation has been a buzzword and a frequently quoted flavor of FUD ever since the inception of Bitcoin over a decade ago. With the recent lawsuits from the SEC against Coinbase and Binance, and broad uncertainty around which tokens are deemed securities, US Regulation has regained center stage.
At a high level, our two main takeaways from the current situation are:
- This regulatory back and forth is good, and shows a natural progression of a new industry.
- The US is potentially shooting themselves in the foot and driving crypto innovation elsewhere.
Regulation — a natural progression
There has been a back and forth between innovation and regulation since the beginning of innovation and regulation. Whether it’s the Luddites destroying new machinery in textile factories or governments passing laws restricting “horseless vehicles” from exceeding 4 mph, there has been a long history of fear when new technology is introduced to the world.
As a more recent example, in the early days of the Internet encryption was illegal and treated as a military grade weapon. Because encryption had this long standing history of being used in warfare (from cyphers in the Revolutionary War, to codebreaking playing a big part of winning WWII) the US Government was wary of Internet Browsers that used encryption and attempted to ban them. The same arguments that are currently being used against crypto were originally hurled at encryption. Fast forward to today, and we can’t imagine entering our credit card information online or send messages from our phones without encryption protecting our data. This back and forth between innovation and regulation is a natural dance that swings from one end of the spectrum to the other, but over the broad arc of history has allowed for innovation to run its course.
It’s also important to bear in mind that almost by definition regulation is several steps behind the new innovation. So, although it might be cringe to watch congressional hearings on crypto and see regulators struggle to understand the technology they’re trying to regulate, you can’t help feeling a bit sorry for them, because as the pace of innovation accelerates so does the difficulty of their job. As Balaji has highlighted, most of our current regulators are setup to regulate a very different world than what we have today. The FAA was designed to keep an eye on Boeing not millions of drone hobbyists. Similarly, the SEC has been the watchdog for Goldman and a handful of banks, so its no wonder they’re struggling to provide regulation on the thousands of cryptocurrencies that exist.
Overall, we think there is more positive than negative that comes out of these SEC lawsuits. While there definitely has been (and likely more to come) some short term pullback on price, paying fines and settling with US regulators is a part of business as usual. US Banks have paid hundreds of billions of dollars since the Global Financial Crisis, but continue operating successfully. This is the most likely path for crypto exchanges as well.
We’ll keep digging into this topic, but in the meantime, here are some highlights of small wins in the current regulatory battle:
Is the US driving away crypto innovation?
Silicon Valley has been the undisputed global innovation hub from computer chips of the 60s and 70s to the “software eating the world” disruption of today. Will that continue for crypto and future innovation? The world is more connected than ever before, and the crypto space is decentralized from its tech to its people. Perhaps the new hub shifts from Silicon Valley to the Metaverse?
We’re already seeing more crypto developers contributing to the space outside of the US than within.
And no longer is it necessary to knock every door on Sand Hill Road to raise money for your crypto project as is shown by the amount of crypto funding occuring overseas.
These facts suggest that it might be the US that ends up missing out on crypto instead of the other way around. A notable example being that a16z opened its first ever international office in London to continue to fund crypto projects internationally.
As Raoul Pal points out, we’ve seen this regulatory arbitrage happen before between the US and the UK. When the US left the gold standard in the ’70s and tightened currency restrictions, the UK became the global hub of all FX Trading. Similarly with Eurodollar and derivatives markets in the ’80s and ‘90s:
Now we are faced with exactly the same opportunity in crypto. The US is fearful of losing control of the dollar system over time, and is scoring own goal after own goal and dragging its heels on attracting the $1trn +crypto industry.
Meanwhile, the UK has made it 100% clear that it wants to go all in to capture this opportunity, using its ace card of regulation arbitrage, in which it excels. The UK understands this. It also has closer alignment with the other much needed partners of HK, Singapore, UAE and offshore centers like Cayman, in order to make this globally successful.
We’re also seeing countries like Hong Kong, Japan and others increasingly put pressure on major banks to support crypto exchanges and other crypto related companies.
This shows that if the US gets too heavy handed, the nimble and decentralized crypto space can quickly adapt and find other places to take their business. We saw this play out already with the closure of Signature and Silvergate Banks. The largest crypto banks got shut down in a weekend, and it was barely even a speed bump for crypto companies.
And, in terms of scoring own goals, Nic Carter highlights a huge missed opportunity for the US as the market share of USDC has continue to slide:
Perhaps unsurprisingly, this chart looks very similar to the US Dollar’s continued decline as a global reserve currency.
Even US Government Leadership is now indicating a slide in the US dollar as world reserve currency with Janet Yellen telling us to “expect a slow decline” and Biden’s chief economist calling for the US to “drop its commitment to maintaining the dollar’s reserve-currency status.”
Yes, the US is still the largest economy and the Dollar is still the world’s reserve currency, so what the SEC and US Government decide to do will undoubtedly impact crypto and can serve as a model that other countries will follow. However, with all of the evidence presented above, I think there’s a strong case to be made that the US stands more to lose from this regulatory battle than does the crypto ecosystem.
Conclusion
Overall, we believe that following the pattern of history, regulation will give enough breathing room for crypto innovation to run its course and deliver on its promise of world changing technologies. And hopefully, the US can continue to play a pivotal role in the crypto journey.
When fear and regulation stand opposite hope and innovation, we will continue to stand with innovation. As Fred Wilson, who has been standing up for crypto against regulation from the very early days, so eloquently says:
When they want to shut it down, I say double down. The most powerful technologies send waves of fear through the establishment. When you see that fear in their eyes, invest in the cause of that fear.
