There is often a perceived tension between regulation and innovation. A pervasive narrative has emerged that these two important parts of our society are at odds with each other.
In reality, it’s when these two come together as partners that we can effect change and transform our world for the better. Nowhere is this more true than in the blockchain industry.
Over the last few months, we’ve seen seemingly reactionary regulators in different parts of the world try to formulate new rules and guidance in silos, without sufficient input from the key stakeholders most knowledgeable about the technology — the innovators themselves.
We saw this in the United States at the end of 2020 when the Financial Crimes Enforcement Network (FinCEN) pushed out a rule proposal that would significantly impact the digital currency landscape. Initially, they only allowed a two-week comment period over the end-of-year holidays. Ultimately, after an outpouring of feedback from stakeholders, FinCEN expanded that period. By all accounts, it is now engaging in a meaningful dialogue with the industry before moving forward with any further rulemaking. However, since then, draft guidance from the Financial Action Task Force has taken FinCEN’s place, looking to enforce the “old way” without seeking input from the private sector.
We saw this again in February when the Central Bank of Nigeria (CBN) issued a circular that sowed confusion about how they viewed digital currencies. It paused the operations of many promising financial technology businesses leveraging blockchain that were unsure how to proceed. However, after stakeholders inside and outside the industry — including other regulatory bodies in Nigeria — voiced concerns, CBN is now set to collaborate with the blockchain industry. They will conduct research to find ways to develop regulations that balance concerns they and others may have, while still allowing the value of blockchain to benefit the region.
Innovations empower regulators
At first blush, innovators and regulators may seem like strange bedfellows. Regulatory bodies have a tremendous duty to protect consumers and deter financial crimes, all while supporting — not squelching — economic opportunity and financial inclusion. Perhaps contrary to popular belief, these are values that innovators in blockchain share with regulators.
The genesis of this technology in many countries, and for many entrepreneurs and innovators, is to provide consumers with greater levels of access and protection. Blockchain can further these goals by offering low-cost, efficient payment capabilities and empowering regulators with greater consumer protection tools.
First, an immutable, public ledger becomes a new tool for transparency and accountability to deter and catch financial criminals. For example, forensic analysis firms like Elliptic have built tools that can identify patterns indicative of illicit activity based on publicly available ledger information. Unlike the traditional banking system, a public ledger allows investigators to see the movement of funds and identify suspicious activity before — or as a method of — identifying criminal activity.
Second, blockchain networks can have compliance functionality built in at the protocol level. For instance, on the Stellar network — an open-source, public blockchain — digital asset issuers can control who owns their assets. Recognizing a need for the ability to recall value from a past transaction when fraud, theft or regulatory action occurs — similar to what’s called a “clawback” in traditional finance — developers for the Stellar network are working on features to enable this functionality. This work underscores that it is possible to leverage the power of decentralization while also providing compelling features from centralized networks that facilitate compliance.
Lastly, there is a whole ecosystem of businesses creating compliance tools that better assess and analyze risk. So not only do companies have the tools they need to comply with existing regulations, but there are innovators ready to adapt those tools as needed. Blockchain technology can be, and is, used in a compliant fashion today. It employs the traditional know your customer and anti-money laundering practices used by regulated financial institutions and the enhanced transaction tracing capabilities afforded by a public ledger. These technological developments open the door to more efficient risk assessments, lowering the barriers to financial inclusion. That’s a testament to how regulation and innovation, when taken in tandem, can change the world for the better.
Dialogue is the Answer
What’s unfolded recently in the regulatory sphere reinforces the importance of an open, collaborative dialogue between stakeholders — public and private — to determine the best ways to regulate blockchain and digital currency. Attempting to create regulatory frameworks behind closed doors or as knee-jerk reactions to perceived risks without regard to potential benefits isn’t a productive way to approach innovation.
To do this right, we need to be working together. Blockchain innovators need a seat at the table to help educate regulators about what this technology is (and isn’t). We want to work together with regulators to shape the guidelines around this technology, addressing their concerns while allowing for innovation in the critical quest to expand access to financial markets and economic opportunity. Creating the right policy and regulatory frameworks for blockchain technology, if done in partnership, can finally put an end to the misconception that regulation and innovation are at odds. We look forward to the role we can play in proving the value of this partnership.