CfR1: Crypto-Regulatory Postures

Crypto for Regulators (CfR), Part 1 —“how to regulate crypto” depends a lot on who’s asking the question.

CleanApp
Crypto Law Review
14 min readOct 27, 2018

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In crypto, when focus turns to regulation, the debate usually moves towards the big questions: to regulate or not regulate, to ban or not ban, and so on. These big questions are important. However,

regulatory analysis today must start from the realization that crypto is already extensively regulated in local, domestic, and international contexts.

A more narrow regulation¹ question is not whether to regulate, but how to regulate. In the course of this Crypto for Regulators series, we will analyze some of these regulation models, tactics, and strategies.

Although the question — should we ban crypto? — is overbroad, it still demands analysis. We must remember that regulators retain vast fiat power to enact outright bans on particular cryptocurrencies or crypto instruments.

Our objective here is to analyze the costs and benefits of an “outright ban” as a regulatory strategy.

A. Outright Ban as Regulatory Strategy

As long as crypto governance theorists wrestle with the potential threats posed by malicious automated blockchain processes, “outright ban” regulatory strategies will continue to proliferate.

This does not mean causation: thinking seriously about threats does NOT mean one is necessarily in favor of a regulatory ban. But there is strong correlation: one mechanism (of many) for dealing with malicious automated blockchain processes is … to outlaw a given malicious blockchain process.

Outright bans can be broad or narrow:

For regulators, balancing competing interests and values along this evolving continuum is a big responsibility. It is not an easy task; and it is rendered especially difficult by various actors pursuing different deregulation or anti-intervention political agendas.

When actors pursue goals like “delegitimizing the regulator,” conflicts over the scope of legitimate exercise of legislative authority and/or regulatory discretion can quickly escalate into misunderstanding and mutual suspicion. These, in turn, can lead to bad policy (in public and private spheres).

B. CleanApp’s Crypto Agenda

In our Crypto for Regulators series, our agenda is to analyze different crypto regulatory options from a neutral, unaffiliated, and non-profit perspective — free of real and apparent conflicts-of-interest. This is the first part of an ongoing conversation on crypto regulatory balancing.

The goal of this series is simple: to offer objective guidance to regulators faced with the difficult task of regulating “the New Internet.”

Our motivation is simple. We believe that crypto has vast economic, technological, and social potential. In fact, despite hyperbole and exaggerated claims, we think today’s crypto discourse actually understates crypto’s full economic, technological, and social potential.

In our view, regulators should resist attempts to define crypto, blockchain, DLT — even along lines proposed by crypto. The main reason for the latter suggestion is that crypto’s views on crypto are changing rapidly. Crypto technology is changing rapidly.

Leading crypto developers understand the nuanced, complex, and often unpredictable ways in which blockchain processes interact with existing socio-economic processes, including existing legal forms. Crypto developers’ understanding of their unique role in the construction of the New Internet gets more nuanced and complex each day.

Lightning-fast innovation includes radical reversal on some of the most seemingly settled positions.

Crypto developers’ willingness to change course shows a clear commitment to network integrity above ideology.

The world has learned a lot about network integrity over the past few years and months. We know that as networks grow, they can become more or less decentralized; they can become more resilient because more people rely on network effects. But technologically and process-wise, networks are also quite fragile. As they grow, networks can become easier to capture and/or centralize. The inability of Silicon Valley behemoths to safeguard user data is Exhibit A in this respect.

Our shared goal should be to incubate and defend innovation that makes networks stronger. This is especially true as machine networks get exponentially more complex.

Greater complexity means that forms and terms that seemed synonymous with crypto just a few months ago — like “cryptocurrency,” “security token,” “smart contract” — are getting more refined. External intervention in this process will increase, but it should not limit the range of political and operational options available to crypto.

Whatever your subjective impression of crypto may be, today’s crypto space objectively represents one of humanity’s best efforts to build a more secure Internet. If you don’t want hackers sorting through your digital or physical trash, then you should let crypto do its thing.

In our view, continued ad hoc external intervention in crypto governance will result in sub-optimal welfare outcomes. Here’s why:

  • Leading blockchain developers and large global blockchain communities are in the midst of active, publicly-open, and increasingly sophisticated blockchain governance debates. These debates should be encouraged and closely followed, not superseded by regulatory fiat. Democratically-constituted grassroots governance processes are demonstrably more effective at achieving good governance aims (broad participation, transparency, efficient dispute resolution, durable structural form, etc.) than externally-mandated governance mechanisms.
  • External regulatory shocks push pan-crypto governance debates out of public forums and onto private backroom channels. Everyone is worse-off as a result of information loss.
  • The costs of external legislative/regulatory attempts to define these terms “for crypto” greatly outweigh the benefits of terminological intervention. Crypto does not need to be told that “smart contracts” are or are not contracts; are or are not “legally enforceable.” All over the world, existing legal processes have millennia of experience with self-proclaimed sui generis legal forms like “smart contract.” There was a time not too long ago when a wax seal “sealed” a “smart contract,” and a seal was necessary to prove formal contractual intent. Not long ago, “electronic signatures” on .pdf documents were of doubtful legal validity. Now they are ubiquitous in commercial practice and court filings. We didn’t need a .PDF & E-Signature Statute to affirm the settled contract formation rule that parties can form contract by almost any means they desire, including electronically. By the same token, there is no need for “Smart Contract” Statutes: their attempts to “clarify” the legal status of “smart contract” forms actually create more confusion, not less.
  • Crypto actors need to (a) debug their own deeply-legalistic source code and (b) overcome internal anxieties towards Law. Both are prerequisites for meaningful engagement with public governance (e.g., Law) processes. External regulatory intervention affirms the myth of “Law v. Crypto; Crypto v. Law” and perpetuates the inaccurate view of crypto networks as dark box networks. Artificially-inflamed antagonism between crypto governance structures and existing governance structures incentivizes opportunistic rent-seeking behavior instead of socially-conscious economic growth.
  • In economic theoretical terms, a crypto-augmented society so clearly Pareto dominates a crypto-less society, that intervention should be kept to a minimum in order to spur continued best efforts and innovation.

These arguments are just a few of the many which we will explore in this Crypto for Regulators series. These arguments will evolve as blockchain technology evolves and as shared expectations evolve.

However the arguments evolve, the general arc of CleanApp’s intervention will remain the same: we are for stronger and deeper analysis, more transparency, and greater net individual, social, and planetary welfare.

We believe regulators must continue to exercise independent analytical and oversight functions — including de novo review of negotiated rulemaking proposals emanating from crypto. Crypto must respect regulators’ core governance functions. Both should welcome objective third party analysis.

C. Crypto Ideologies & Politics

We are mindful that many crypto evangelists characterize “crypto” as a political project, rooted in different streams of political economic theory. There are many detailed introductions to the personal and institutionalized “politics of crypto.”

We recommend Nick Paumgarten’s New Yorker article, The Prophets of Cryptocurrency Survey the Boom & Bust because it is the most recent, gives a great chronological overview of crypto, and offers excellent first-hand reporting.

The overt political nature of certain crypto projects is undeniable. But after overcoming initial learning curves, one observes a rich pluralism of ideological and political orientations within the rapidly-evolving crypto sector. This is one of the most surprising and reassuring facets of today’s crypto space, and something one cannot appreciate from scanning #CryptoTwitter or relying on traditional institutional expertise.²

Like today’s corporations, many crypto projects are expressly ambivalent on questions of politics or ideology — they just want to make money, and/or introduce new technologies, and/or experiment with new modes of economic organization (e.g., blockchain-based sharing economy models).

It a mistake to generalize and ascribe a political/ideological orientation to the crypto sector as a whole.

But it’s also a grave mistake to assume that crypto actors are politically benign. As Vlad Zamfir points out in his research on proof-of-stake consensus protocols & blockchain governance, crypto actors are very savvy political animals — on-chain & off-chain.

D. Crypto Crimes & Cartels

Crypto operators are incredibly creative when it comes to cartel formation, inventing new ways to circumvent crypto versions of antitrust rules, practicing censorship, and so on. This applies to crypto trading, background processes like “crypto mining pools,” and even inter-crypto developer turf wars.

But cartels (or criminal market & network activity) are not unique to crypto. Antitrust enforcement is difficult in global markets, even for extremely powerful investigatory and enforcement organs like the European Commission. White collar prosecution for insider trading and other financial market crimes is notoriously inconsistent.

Just today, Richard Usher, Rohan Ramchandani and Christopher Ashton, three British members of a currency-trading cartel that called itself “The Cartel” were found not guilty of coordinating trades and manipulating currency exchange spot prices for euros and dollars.

Crypto’s combative rhetoric, politically-loaded source code, and early origins in the dark web give regulators more than enough “substantial and deleterious effects” to exercise prescriptive jurisdiction.

Indeed, crypto claims to pose such a threat to the global fractional reserve banking system that one could even make a universal jurisdiction argument for regulating crypto. It’s not hard to imagine unscrupulous crypto developers likened to pirates and hunted by autonomous killer bots executing on-chain “self-enforcement” on behalf of an especially ruthless regime.

E. Crypto-Regulatory Trolling

In moments like these we must remember that while crypto ideologues seem to revel in taunting regulators, much of that is just internet trolling. Many of the same coders meet with regulators and enjoy learning from their expertise.

Moreover, many developers are foregoing astronomical individual wealth in order to “do something meaningful for society.” In other words, though the means they employ may be unconventional, many crypto developers are pursuing the same goals that regulators are: building a more liveable world. Crypto devs may have huge potential power, but they also enjoy exposing the brittle nature of power as such.

A crypto developer once told a journalist,

“I saw everything to do with either government regulation or corporate control as just being plain evil. And I assumed that people in those institutions were kind of like Mr. Burns, sitting behind their desks saying, ‘Excellent. How can I screw a thousand people over this time?’”

Like the decision to name snippets of code “smart contracts,” the Simpsonian Mr. Burns analogy seems more akin to regulatory trolling than actual political programming. It’s deconstructive propaganda, rather than narrowly constructive agenda. Simplistic binary politics (Us v. Regulators) is a proven social organizing strategy, and if that’s crypto’s recruitment tactic, for instance, it makes complete sense.

Moreover, regulators should be careful when writing authoritative narratives on crypto’s rise or when doing crypto institutional mapping. There’s no need to reinvent the wheel — take it from a non-profit that has spent several years trying to do crypto institutional mapping.

The cyberphunk sub-culture that infuses much of today’s crypto permits some of the most serious minds to self-identify as “absurdists” and “trolls.” In this topsy-turvy world, some of the most “serious” voices often say the most actually absurd things. Others crypto theorists seem to favor disinformation strategies of control. Crypto socio-legal discourse is especially disorienting due to creative usage of settled legal terms along radically unconventional lines.

Against this backdrop, the clear trend we observe is crypto ambivalence towards law and regulation, not opposition to regulation.

Though they may not say so expressly, some of the today’s most anti-interventionist Bitcoin billionaires and the most strident “crypto-anarchists” actually stand to benefit the most from clear taxation regimes that permit them to legitimize their crypto earnings. The same goes for crypto-specific inter-generational wealth transfer rules, and so on.

The Crypto v. Law posture seems to invite regulators to a game of cat-and-mouse. First, coders invite regulators onto the playground by projecting supreme confidence in their own conception of code: crypto coders will win because they are younger, more nimble, and they control the New Internet.

But very quickly, everyone sees additional layers to the game.

  1. coders may technically control the New Internet, but regulators control the “Law of the New Internet,” which means regulators exercise immense control over coders;
  2. the New Internet is global, but regulators think in hyper-territorial boxes; regulators may not be able to snag a crypto mouse extra-territorially, but regulators can set plenty of mouse-traps all over the world;
  3. while coders may technically control the New Internet today, they may not want to control it tomorrow.
  4. smart coders realize that the coders who desperately want to control the New Internet are probably people who should have minimal access to any mechanism of control;
  5. […]

The crypto developer who invoked Mr. Burns was none other than Vitalik Buterin, the founder of Ethereum (by many measures, today’s largest blockchain project). Today, he and others would probably concede that, proportionally, there are as many Mr. Burns-es in crypto as there are are in regulatory agencies and on corporate boards.

The bottom line on crypto regulatory trolling is that if crypto price action hinges on regulatory decisions, then crypto actors interested in gaming price will keep doing so by gaming regulators. If vast fortunes hinge on maintaining 51% control over a given blockchain (to censor competing nodes), then those whose fortunes hinge on that control will use every lever at their disposal — including regulatory action, anywhere in the world.

We can think of crypto-regulatory trolling as an off-chain layer for pursuing blockchain cartel politics. In this sense, crypto-regulatory gamesmanship is just an additional mechanism for taking blockchain offensive and defensive action, off-chain.

F. Crypto Power Games

The coders who realize the limits of their control over the New Internet they helped build are also actively working to develop robust participatory democratic governance models. In this respect, regulators have much to learn from crypto, instead of the other way around.

In an extraordinary prudential move befitting Lucius Quinctius Cincinnatus, many top blockchain developers are expressly handing over governance control over the global blockchain to diffused groups of global stakeholders.

Here is Vlad Zamfir:

Crypto theorists aren’t just pondering ideal governance outcomes and mechanisms. They are actively building and implementing experimental constitutional designs, secure voting mechanisms, governance participation incentive schemes, novel dispute resolution processes, and so on.

A complete ban on crypto or a particular crypto project would effectively destroy one of the most active governance sandbox and prototyping environments the world has ever produced.

G. Scale is Everything

As we consider complete ban as a regulatory strategy, we must always keep scale in mind.

The market value of all crypto taken together today is approximately $210B. That figure represents 73% of WalMart’s market cap $286B (as of October 25, 2018).

One year ago, Julie Maupin published a Centre for International Governance Innovation (CIGI) report titled Mapping the Global Legal Landscape of Blockchain and Other Distributed Ledger Technologies.

In the report, Maupin proposes a tripartite taxonomy for analyzing crypto activities (and corresponding regulatory strategies): (1) recycle box, (2) dark box, (3) sandbox. By dividing the crypto space, this model helps us appreciate crypto’s relatively modest existing scale.

Below is our understanding of this typology, along with our examples of use cases that fit in these respective categories.

  1. The recycle box includes uncontroversial crypto use cases — embodiments that, say, greatly increase the speed and transparency of judicial docket processing in small-scale parking ticket disputes. Regulation is not needed for use cases that fit in this box.
  2. The dark box includes universally deplorable crypto use cases, such as uses of crypto processes and instruments to effectuate child sex trafficking, slavery, and arms smuggling. Regulatory frameworks for activities that fit in this box are already so well-developed that extension to crypto is not only inevitable, but in many instances, has already taken place (even if enforcement under these authorities has not yet ramped up).
  3. The sandbox includes use cases that are of an experimental, innovative, unprecedented nature. Regulation is appropriate in some cases (such as combining AI processes with blockchain to automate and weaponize on-chain “enforcement”). But regulation would not be appropriate in other cases, such as experimental uses of blockchain technology in the healthcare sector (e.g., Smart X-Ray chaining together disparate X-rays from a given patient to securely track the spread of disease; Smartr X-Ray chaining together of similar X-rays from different patients to detect commonalities & differences that can lead to diagnostic breakthroughs).

Maupin’s framework — especially the dark box — allows us to acknowledge that crypto actors may have shady pasts or they may have current ideological preferences that we find suspect.

Acknowledging, contextualizing, and bracketing these concerns allows us to focus on shorter merits-based arguments addressed to hypothetical regulators contemplating “a complete ban on cryptocurrencies.” For instance:

H. Sum

Regulators should safeguard crypto’s freedom of action to the maximum extent possible. This is necessary to actualize significant near term welfare gains from crypto: not through the usual chimera of “trickle down” logic, but through concrete material benefits from breakthroughs like (1) distributed computing, (2) secure IoT interoperability, and (3) orders-of-magnitude more efficient material resource use.

CleanApp Foundation is actively working to incentivize, recognize, and publicize crypto’s material potential. We are also actively developing the legal architecture of the New Internet. Please join us at www.cleanapp.io.

¹ We use the word “regulation” to refer to any type of legal intervention, including legislation, regulation, negotiated rulemaking, public rulemaking, adjudication, interpretation, and so on. By regulation, we mean the legitimate exercise of jurisdictional authority by different local, State, and international actors. Regulatory authority is complex and terminology varies, but underlying regulatory logics are sufficiently similar in this context. As a heuristic, we use the word “regulation” to refer to the broad suite of discrete regulatory tools (see above), available to actors who want to exert jurisdiction over crypto.

² In September 2017, Jamie Dimon (the CEO of America’s largest bank, JP Morgan Chase), famously called Bitcoin “a fraud.” In early 2018, he said he regretted the comment; by August 2018, Dimon corrected himself: Bitcoin was not a fraud, it was a “scam.”

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CleanApp
Crypto Law Review

global coordination game for waste/hazard mapping (www.cleanapp.io) ::: jurisdiction mapping ::: no token yet, but launching research token soon 💚🌱