Cryptoassets need their Part 107 moment

We’re in the early days of a technological breakthrough that has the potential for enormous societal impact, but challenges remain.

First, it has a reputation problem. Many of its use cases are viewed as detrimental to society and these are top of mind for the general public. When I tell people about my involvement with this technology they often don’t understand it and/or criticize it.

Perhaps more importantly, it has a regulatory problem. It’s not clear how the regulation will evolve in the US and every agency seems to be moving at a snail’s pace relative to the rate of technological change. As a result, much of the innovation is occurring outside US borders.

I could be describing the current state of cryptoassets, such as bitcoin and ether, but I’m not.

I’m describing drones in 2012.

I’ve seen this movie before, and even the version I saw was a rerun. Technology always moves faster than regulation. It happened with commercial drones, the Internet, aircraft, motor vehicles, and nearly every major technological adoption in history. Regulation eventually catches up, and if done well it provides far more benefit than harm.

For example, the pioneers in the automobile industry were able to drive around free from the tyranny of traffic lights. However, in order to scale, regulating traffic flow became a necessity. Have you ever approached a busy intersection during a power outage? The value of regulatory clarity becomes readily apparent when we are temporarily deprived of it.

I was part of a group that founded Skyward, a company building software for managing commercial drone operations. We began at a time when flying drones commercially was illegal in the US. Regulatory risk was a topic of conversation at every investor pitch.

Although there was a faction of the industry that was anti-compliance, most of us just wanted clarity. We were willing to follow some rules, but no one had defined the rules. Jonathan Evans, Skyward’s CEO, met with governors, senators, and US representatives seeking help. The US is losing the opportunity for leadership in this space he (and many others) told them. The cutting edge developments were happening in places like China, Africa, and Canada.

Bills were introduced, calls were made, and eventually Part 107 of the FAA code was drafted. It provided a set of guidelines to obtain a commercial drone pilot’s license, paving the way to legal commercial operations. Yes, there was some work required to comply, but most industry participants were happy to do so if it meant being able to operate legally. Part 107 opened the floodgates for the industry as nearly every major corporation began to develop a drone policy. Regulation didn’t inhibit adoption, it enabled it.

Bitcoin, and cryptoassets generally, are desperately in need of their Part 107 moment. It will be more complicated and drawn out than a single rule; we need to accelerate towards regulatory clarity along a variety of dimensions. I defer a discussion of the details to organizations like Coin Center that are thinking carefully about these issues, but here are three broad areas where regulatory reform would bolster the likelihood that innovation occurs within the US…

  1. FinCEN: Blockchain technology creates numerous gray areas in terms of money transmission, AML/KYC, and the Bank Secrecy Act. The current regulation is unclear on several fronts.
  2. SEC: 1) Endorse a set of standards that will pass the Howey Test. 2) Create a pathway for non-accredited investors to invest in security tokens that don’t pass the Howey Test. Seemingly, this could be accomplished via a mechanism like Title III of the JOBS act, but it would need some alteration that I will address in a future post.
  3. IRS: Establish a de minimis tax rule for cryptoassets. Recording a capital gains entry every time I buy a cup of coffee is silly. It is a virtual guarantee that the prevailing market price of the bitcoin I have in my wallet is different now compared to when I bought it. That is true whether I bought it two years ago, two months ago, or two minutes ago. This means that in order to use cryptos for everyday purchases I need to file a very lengthy Schedule D (IRS capital gains form). That’s either going to deter use or deter reporting. Neither are ideal.

In the drone industry, the FAA, NASA, and other agencies actively convened industry leaders leading up to Part 107. Some of this is already happening in the cryptoassets space, which is encouraging. In the meantime, the flow of innovation continues to move towards places like Zug, Switzerland where the regulatory environment is more conducive to spurring development around blockchain technology.

Bitcoin, Ethereum, and a plethora of token protocols have seen a marked rise in attention, value, and scrutiny in 2017, but they will flourish to an even greater extent once the US regulators create pathways for compliance. The aggregate network value of all cryptoassets is roughly $100 billion as of this writing, suggesting that we haven’t begun to see the effect of a rotation towards cryptoassets from major financial institutions like pension funds, insurance companies, and sovereign wealth funds. We also have yet to see mass adoption of cryptos as a method of payment. These things will be accelerated by clear regulation. I have confidence that it is only a matter of time, just as it has been for every technological revolution in history. The trillion dollar question is: how much longer will we need to wait?

I thank Jerry Brito, Chris Burniske, and Matt Chwierut for comments on earlier drafts of this post.