Despite a major down year for cryptocurrencies in 2022, blockchain — the underlying technology that enables cryptocurrencies as well as other developing technologies — suffered no real ill effects. In fact, the European Commission announced Wednesday the launch of the "sandbox" test site designed to foster 20 blockchain-based projects per year. Industry experts say several factors still provide the U.S. a massive opportunity to take the lead in blockchain applications. But there is a rising risk of squandering that opportunity, they say, unless pertinent regulations are quickly clarified.
Blockchain: Not A Fringe Asset
Blockchain performs a variety of functions, underpinning a wide array of technologies other than cryptocurrencies and NFTs (non-fungible tokens). But cryptos provide blockchain its highest profile exposure. And it is not an inconsequential role to play.
"This is not a fringe asset … roughly one-fifth of Americans, it's estimated, use or hold crypto," according to Maude Wilson. She is policy counsel at decentralized-finance firm Uniswap Labs. Wilson was a speaker on the "Making America #1 in Blockchain and Financial Innovation" panel at CES 2023 in Las Vegas.
"For people that live in places where there's less trust in their government, less trust in their financial institutions, those numbers are even higher," Wilson said. "We're seeing up to one-third of people living in Argentina using crypto."
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Argentines have embraced crypto currencies as the country's inflation approaches 100% and its currency evaporates. El Salvador embraced Bitcoin as domestic legal tender in September 2021. It began buying one Bitcoin per month in November, after the FTX-triggered crash. In January, the country's legislature made legal the use of bonds backed by cryptocurrency.
The EC's European Blockchain Regulatory Sandbox launch on Wednesday gave the region an aggressive stance in the developing technology. First announced in 2020, the project connects regulators, academics and corporate innovators with an aim to move projects forward rapidly and with oversight.
It is facilitated by a consortium under the lead of London-based law firm Bird & Bird, along with its consulting arm OXYGY, and blockchain experts of WBNoDE, a Czech Republic-based website builder system. The sandbox targets 20 projects per year, beginning in 2023.
Decentralization And Web3
In the U.S., proponents say that cryptocurrency payments can help eliminate credit card fees and cut out middlemen. That, Wilson says, provides trickle-down benefits to consumers.
Also, blockchain enables decentralization of Web3 — the next revision of the internet. Exactly what decentralization might offer and look like isn't yet exactly clear. But experts believe we'll start to see that expansion in the coming year. Sasha Moss, public policy manager at Coinbase, said Web3 will offer customers "more privacy by design and interoperability between platforms."
Blockchain technology will also appear in more mainstream uses, according to Moss. Artists and concert venues will begin using non-fungible tokens for tickets. In addition, brands of all sorts will use NFTs for rewards programs or other digital collectibles.
Web3 will also offer "more ownership control among users for their data." Also, a more decentralized system that's more robust, less concentrated to the power of big, multinational corporations," according to Jacob Hample. Hample is head of U.S. government affairs at the Filecoin Foundation. The Filecoin Foundation supports and provides grants to decentralized startups.
America Lags
Still, America's lack of crypto regulation means it lags many competing nations. The European Union launched the draft of its crypto assets regulations in June. The rules, which are expected to go into effect in December this year, hold providers liable for loss of consumer crypto assets.
"Europe has been far ahead of the United States on trade, especially market recognition," Hample said. The European Union's regulatory framework, the Market in Crypto-assets Regulation (MiCA) will roll out this year after its expected formal approval in April. It was originally slated for February but was delayed to translate it into Europe's various languages.
On Wednesday, a tweet from Coinbase CEO Brian Armstrong called for quick legislation from Congress after Hong Kong announced it will make crypto buying, selling and trading fully legal for its citizens starting June 1.
However, America has a huge opportunity to take the lead in the industry, according to Lizzy Fallon, policy advisor for the U.S. House of Representatives. Particularly after China banned all cryptocurrency mining and transactions in late 2021, Fallon says.
Clarifying The Crypto Basics
As the first step in that process, regulators first need to define the basics.
"We still don't have regulatory clarity on what digital assets are securities, what digital assets are commodities, and what digital assets are currency," according to Fallon.
"And what we hear from crypto developers is that it's hard for them to develop in this country," Fallon said. That's because they can't offer their token to U.S. citizens as payment, since it might be deemed a security risk.
The current federal framework, the 1933 Securities Act, simply can't be properly applied to crypto or the blockchain, some say. "We're talking about legislation that is almost 100 years old … we just want the regulation to be fair and to apply to the technology we're talking about specifically," Uniswap Labs' Wilson said.
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Regulation May Resemble Internet Laws
Proper regulation of the industry may need to resemble internet laws, analysts say, rather than focusing on the financial aspects of the technology. Policies need to avoid pigeonholing the technology, but also to reflect American values of privacy, individual sovereignty and free markets, House policy advisor Fallon said.
The current crypto framework is "more of a state-based framework that's fragmented," according to Fallon. And at the federal level there's competition over jurisdiction, which makes the system very difficult for market participants to navigate. Congress needs to define "who has jurisdiction over what, when and why, and go from there," she said.
"Most people in the industry are really looking for laws that are specific to the U.S. — laws that take the nuances of the technology into account," Fallon said. "This is a space that wants to be regulated. It just wants to be regulated thoughtfully and in a way that makes sense."
Cryptocurrency, Blockchain Regulation Ahead
Regulation is likely to focus on centralized exchanges, such as FTX, that have remained outside the purview of U.S. regulators and initiated many of the recent crypto crashes.
Fallon points out that the technology anticipates many of the issues that regulation seeks to solve and to mitigate. She noted that blockchain's transparency allowed crypto sleuths to track some FTX funds during its crash and helped unveil certain aspects of FTX and Alameda Research's intertwined relationship.
A lot of financial regulation aims to address custodial risk and information asymmetry — those who have access to information taking advantage of those who do not. Decentralized finance naturally addresses these issues, Wilson says. DeFi never takes custody of assets, meaning there aren't custody risks. And everything registers permanently on the blockchain, which means filing disclosures and other transparency measures from traditional finance aren't relevant, she said.
So regulators need to be aware of those discrepancies. Meanwhile, public centralized exchanges such as Coinbase maintain their transparency via securities filings and adherence to U.S. financial laws, Moss noted.
Jake Chervinsky, chief policy officer for the Blockchain Association industry group, says Congress, rather than the Securities and Exchange Commission, will likely have to step up to regulate blockchain.
"In recent years, important government bodies like (the Financial Stability Oversight Council) and the (President's Working Group) have said Congress — not the agencies — must decide crypto regulation. That hasn't happened, and now we have a divided Congress," Chervinsky said in a Feb. 14 tweet.
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But Congress is clearly in motion, with House Republicans, in particular, pressing the issue.
"There's many pieces of legislation on the table that have great bipartisan support and have good support from stakeholders that would be impacted by it. So in large measure what's needed, Fallon said, is "piecing it together in a way that makes sense."
Discussions on stablecoin regulation began back in August and those bipartisan talks are ongoing, she said. And in light of the recent events, we'll likely see market structure legislation emerge as a priority for the 118th Congress.
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Fallon expects "a lot of great crypto developments" from the Financial Services Committee, now under the leadership of Rep. Patrick McHenry (R-N.C.).
"2023 is the year for oversight," Fallon said. She expects Republicans to flex their "subpoena power," forcing the Securities and Exchange Commission into a more active stance on engaging on cryptocurrency and blockchain regulation.
"It's the year that (SEC Chairman) Gary Gensler should get a cot," Fallon said, "because he's going to be testifying in front of Congress a lot more."
You can follow Harrison Miller for more stock news and updates on Twitter @IBD_Harrison
