Thinking Inside the (Regulatory Sand) Box

Haebin Lee
Apr 5, 2019 · 8 min read

New ideas don’t get old, and neither should regulations.

Thinking out of the box by Baldo384

Looking back at my college years in South Korea studying business, one thing that I realized is that business schools rarely teach students how to deal with the complex dynamics of business and regulations. In fact, it was no surprise that regulation was often depicted as ‘a bothersome obstacle that hurts the entrepreneurship.’ While schools encouraging young, potential entrepreneurs to focus on shiny new business models, regulation was nobody’s interest. So, the lesson implied was clear — Dodge regulations as much as you can. Since I graduated and joined a startup, exciting moments often include thinking outside the box while baffling moments almost always involved with the thought, ‘How on earth can we develop this idea under the existing regulation and not be regarded as a criminal?’ The minute I stepped into the wilderness of entrepreneurship, it was not hard for me to realize the significance of regulation in pushing our thoughts outside the box.

When it comes to regulatory ‘difficulties’ for startups, it can be primarily narrowed down to two scenarios: having too many regulations or too little. Startups in such situations are no different from a group of explorers lost in a dense jungle or a boundless sea of regulations. Which is worse? That is hard to tell. Either of them may be deadly, as finding an exit route and even navigating would be extremely difficult. When there are too many regulations, it is often the case that the entry barrier is tough to break and the vested rights are well protected.

Even if the entry was successful, startups could not avoid constant attack from regulations. One example that took place in Korea, 2016, vividly illustrated such attack. A startup called Hey Dealer, an online reverse auction platform for used cars was off to a great start and reached nearly 25 million USD of transactions within a year.[1] Then a strange thing happened. The National Assembly passed a revised bill, promoted by offline used car dealers, that mandate every ‘online’ car dealer to have a nearly one-acre of a parking lot and a wide auction space. Knowing that startups such as Hey Dealer cannot afford to have such facilities, this bill was aimed at driving out any new competitors in the market. Hey Dealer’s business came to a halt without resources to meet these new requirements. After the massive backlash from the media and the public, the bill was soon withdrawn by the Korean Ministry of Transportation. It was recorded as the first bill ever to be passed at the assembly and withdrawn just within a month in Korean history.[2]

At this point, startups may think that a golden saying, ‘Less is more,’ cannot be more appropriate when it comes to regulations. Sadly, the bad news is that the absence of regulation is no better than having too many. A Regulatory void exists when there is no regulation or precedent to define or regulate the agenda of interest legally. This void becomes more visible with the rise of innovation. Although this void offers new opportunities with no incumbents to fiddle with regulations, it does not always guarantee startups freedom to experiment with their ideas. Instead, it often means that they are passing through a minefield without any fence or caution tape around it. Just as regulators who cannot expect what innovation is on the way, entrepreneurs can hardly foresee when and how regulators will react to their new ideas. Without a lobbying power or resilience, any sudden action taken by regulators may be fatal to startups. Also, startups are still likely to be called ‘illegal,’ primarily because they do not fit into the existing framework that defines what is legal or not.

It seems clear that any extreme degree of regulation can be detrimental for startups. Now, here are my questions; How can regulation find the balance in its degree whenever new and unidentifiable ideas come up? How can regulatory authority accurately examine their pros and cons? These questions should consider how regulations approach ‘something new.’ Regulatory authorities, just like any other organizations, are subject to organizational inertia. It suggests that their behaviors follow a certain path over and over again, which explains why regulatory stances — whether lenient or hostile — hardly ever changes. However, regulators now face pressure for agility to keep up with innovation, pushing them to step out of their comfort zone. Before discussing further, I broadly categorized regulatory stances toward ‘something new’ into three types as below.

The first category is ‘Wait and See.’ This type of regulatory authority pursue passive regulation. Of course, every regulatory authority’s initial reaction to a new agenda that lies outside the purview would be the same. What’s different is that the authorities that fall into this category prioritize ‘benign neglect’ toward such an agenda. They let new things grow until they cause obvious problems. One of the examples of such category is the ‘Do no harm’ policy of the United States on internet commerce which was first initiated back in the late 1990s and still resonates until today.[3] Recently, the UK government also addressed the digital policy design principles that include, ‘Do Less: Government should only do what only government can do.’[4]

The second category is ‘Active Embracement.’ Noticeable examples come from eastern Europe. Estonia, Malta, and Gibraltar are among the nations which have actively legislated policy regarding blockchain and cryptocurrency industry. Their efforts to embrace new technology and its potential have been successful not only in attracting global startups but also in transforming their identities as government.

Cullum, L. (1925). Never, ever think outside the box [Cartoon]. The New Yorker Magazine.

The third type is ‘Strict Control.’ This type of regulatory stances tends to assume that innovation can be defined and thus be strictly controlled within the scope of new regulations. In this perspective, the potential benefit of innovation is likely to be outweighed by its downside. These authorities tend to prioritize consumers protection and regulatory validity over the growth of innovation. South Korea would be a good example to illustrate this type when it comes to the blockchain and cryptocurrency industry. As one of only two countries in the world with a total ban on ICO along with China, the South Korean government has faced criticism from startups and public investors.[5] Stating that ICOs entail high investment risk and fraudulent and the possibility of fraud, South Korean regulators have kept cryptocurrency and blockchain industry within their tight control.

So, it is a dilemma for regulators as well. It is a high risk to take quick regulatory action for new ideas without thoroughly evaluating them not to mention it also involves a rigorous understanding of new ideas to come up with proper regulation. If they do not take any action, however, regulatory uncertainty lingers, and consumer protection may not be viable. As competition between nations to attract bright innovators and entrepreneurs is on the rise, any regulatory hesitancy to interact with startups will come costly. Then, what can be done? Let us take a look at a hybrid model that stands in the common ground of all three regulatory stances mentioned above.

Initiated by the UK in 2015, a ‘Regulatory Sandbox’ is a box for thoughts outside the box. It aims to provide a selected group of startups with an opportunity to test their business models in the market to under the customized regulatory environment for a limited duration.[6] If startups prove its business to be beneficial to consumers within consumer protection guidelines, they can ride the fast-track to the market with less regulatory risk by obtaining a regulatory approval to operate outside the existing regulatory framework. While buying time for both regulators and startups to identify which regulatory measures to be taken, a regulatory sandbox relieves the dilemma of regulators and the legal uncertainty facing the startups. It suggests a new direction for how regulations should evolve to keep up with the pace of startups.

The impact of regulatory sandbox projects may be beyond everyone’s expectation. A regulatory stance, once regarded as a tough boundary to cross, may take a new turn with it. For example, South Korea, one of the harshest regulatory environments, adopted regulatory sandbox program last year and just announced a list of fintech startups eligible for its early screening process. Surprisingly enough, the list includes the STO (Security Token Offering) project in the real estate industry called ‘Kasa Korea,’ which includes not only blockchain technology but also digital tokenization of assets.[7] If this STO project makes it to the success in the sandbox, it will make a precedent of STO-related regulations and shed a new light on its potential in Korea. Regulatory sandbox gradually yet thoroughly expands the boundary of regulations to better embrace new ideas. Although the final decision is yet to be made, it shows that the wind of change is blowing into the South Korean authority’s strict stance on blockchain business and asset tokenization.

Great innovation starts with thoughts outside the box. And yes, it is extremely difficult to tell whether a specific innovation turns out to be ‘good’ bringing improvement to many lives. If innovations are found out to be ‘bad’ doing the exact opposite, regulations should provide an adequate protection for consumers against it. This suggests, either way, regulations need to consistently keep up with the pace of innovation.

Coming up with good innovation is not a duty of regulations, but the protection of it is — as it provides a momentum to drive our society forward. Although simply providing startups with a sandbox to play with does not guarantee the emergence of great innovation, this social experiment may provide a solid starting point. Allowing a small regulatory safety zone for startups may provide a quick yet thorough way for regulators to step out of an old regulatory trajectory, keeping up with the speed of innovation. New ideas don’t get old, and neither should regulations.

* The opinions expressed in this article are those of the author and do not necessarily reflect the official position of Block Crafters. Any comments are welcome and can be sent to h.lee@blockcrafters.com

[1] Korea Joongang Daily, Jan 22, 2016, “Bad deal for Hey Dealer.”

[2] 구태언, 2018, 2장 혁신기업들은 법률 전쟁 중이다, ≪미래는 규제할 수 없다≫, pp. 67–69, 클라우드나인, 서울.

[3] The New York Time, “Clinton Issues ‘Hands Off’ Policy on Internet Commerce”, July 2, 1997.

[4] UK Government, “Government design principles”, 3 April 2012.

[5] Forbes, “South Korean Startups Are Preparing To Fight The Government’s ICO Ban,” October 3, 2017.

[6] Financial Conduct Authority, “Regulatory sandbox”, 2015.

[7] Financial Services Commission, “금융혁신의 실험장, 금융규제 샌드박스 시행”, April 1, 2019

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