By: David Vandervort
If I had a crypto-libertarian outlook, I might be quite happy with the SEC’s decision this week to deny a rules change that would allow the Winklevoss brothers to publicly open their Bitcoin Exchange Trading Fund (ETF). On the plus side, the spectre of cryptocurrencies being shoe-horned into the role of “financial vehicles,” where regulation is the norm and very large amounts of money are a prerequisite for being involved, has been delayed, if not completely side-tracked. Or to put it more simply, if you don’t like Wall Street, the SEC’s negative response to the Winklevoss fund is a good thing for cryptocurrencies.
As far back as the white paper in which Satoshi Nakamoto introduced Bitcoin, there has been a strong streak of financial rebellion in the cryptocurrency world. There is considerable appeal to the idea that the blockchain removes the need to trust third parties, like bankers and regulators, with your money. It doesn’t just lower transaction fees, it makes the world a little more free. Blockchain-enabled smart contracts, giving rise to concepts such as Distributed Autonomous Organizations, where software automatically makes many decisions without human intervention, push this idea even farther. Why do we need regulators at all if it can all be programmed?
Appealing though those ideas might seem, there is a definite trend toward more regulation of cryptocurrencies. The Winklevoss setback illustrates the point. The SEC reasoning (text of the decision at: https://www.sec.gov/rules/sro/batsbzx/2017/34-80206.pdf) was straight forward. The SEC requires that any ETF have enough information available that a credible investigation of fraud or other illegal activity on that exchange can be performed. Further, since ETFs do business with other entities like them, the SEC requires that those other entities also have that kind of information available, so that investigations don’t hit a stone wall when the trail of evidence leads off of a particular site. Bitcoin intentionally obscures much of the information that would be needed to pursue a fraud or money laundering investigation and there are, apparently, not enough laws in other jurisdictions forcing ETFs in other countries to find and provide that information anyway. The SEC concluded, basically, that it cannot protect consumers who would do business with the Winklevoss ETF, therefore it will not allow the ETF to do business.
It all sounds very logical. From a law enforcement perspective, maybe it is. It simply ignores the possibility that people could get protection through other means, such as by buying insurance, or by being careful about how much money they are risk in any particular market. Two smart guys like the Winklevoss’s might even be willing to spend money to develop AI-powered fraud detection algorithms, a field that is currently very hot. Why not allow that?
Because that’s not the way the regulations were written. When the regulations were written, or more likely when the regulators were learning about their field, the idea of Artificial Intelligence fighting fraud (Should we call it MoneyNet?) was not even on anyone’s radar. I would call it science fiction except that in a lifetime of reading science fiction, that particular idea is not one I remember ever seeing.
This brings us to the underlying tension between the realities of a regulated world and the ideology of crypto-based finance giving everyone more freedom and more control over their own affairs. Fraud is a real problem. Money-laundering is a real problem (though whether or not the laws against these things are good solutions is an entirely different question we won’t be considering today). Anti-usury laws go back thousands of years! (https://en.wikipedia.org/wiki/Usury). Modern banks, investment houses, insurance companies and assorted other financial entities have evolved to survive in this regulated landscape. Bitcoin, Ether and other cryptocurrencies are only getting started.
This does not mean that all is lost. Just a few weeks ago, the Arizona state legislature passed by a vote of 49–0, a bill that formally recognizes smart contracts as legitimately transferring asset ownership. It also affirms a signature stored on a blockchain as a legally binding electronic signature. This is an example of government helping advance the freedom to use the technology as we choose.
The bill has not yet passed the Arizona Senate (Keep an eye on it here: https://legiscan.com/AZ/bill/HB2417/2017). Whether it does or not, it should be model legislation for the other states and even for the federal government. It has been said that a contract is a promise the government will enforce. This bill says that a smart contract is enforceable, at least some of the time. That reduces the possibility that someone could sue over a perfectly executed smart contract and get their money back. That’s important.
A purist might say that the world of blockchain technology would be better off without any government interference, either way, but we don’t live in a pure world. We live in a world where regulators have great power and sometimes do things we would rather they didn’t. I live in New York, home of the BitLicense (https://en.wikipedia.org/wiki/BitLicense) which is less helpful than the bill in Arizona but also not as immense a roadblock as the SEC Winklevoss decision. In the middle, the Ontario Securities Commission recently issued a warning that companies seeking to deal in blockchain-based finance, Initial Coin Offerings in particular, should contact them to ensure that they are in compliance with existing securities laws (https://www.coindesk.com/ontario-securities-regulator-warning-ico-blockchain). They didn’t come right out and say no, and they didn’t say yes, either. Unless this is some strange form of sting operation, at least they are willing to talk.
The problems of regulation may not be entirely caused by lack of understanding or by a profound difference in philosophy between regulators and crypto-freedom enthusiasts. The immaturity of blockchain and smart contract technology probably plays into it as well. The death of the DAO last summer was a high profile reminder that the world is at the start of the learning curve when it comes to smart contract security. When it comes to security, experience matters and currently no one has very much experience in the field. If I were a regulator, I would worry, too.
But being worried is no excuse for being a roadblock. While the American SEC has said no (for now), they have created an opening for others to work with the community to try to find ways of solving problems. And by “opening,” I mean “potentially lucrative consulting opportunity.” Those who have even a little experience in blockchain and smart contract security, should be in high demand, That especially now that the Enterprise Ethereum Alliance is bringing many high stakes finance players together in attempting to adapt blockchains to commercial uses. The EEA may, indeed, be a force in convincing regulators to worry less, and approve more. That alone would be an achievement.
It has been said that, in science, new theories advance only as the generation believing in the old ones dies off. The regulatory environment does not appear to be quite that conservative. Consider that Satoshi Nakamoto announced Bitcoin only 8 years ago, and already his creation has been banned in multiple places, licensed,, and explicitly allowed in others. This so clearly shows that regulations can change quickly, that lawmakers may actually respond to what is going on, and that mistakes in over regulation might actually be revisited or even corrected. As the technology matures, and the skills to deal with it improve, we might yet see some kind of happy medium between regulation for safety and law enforcement on one hand, and freedom and economic innovation on the other.
Just don’t ask me to say exactly when that point will be.