The collapse of the cryptocurrency exchange FTX checked all the tech-cynics’ boxes. A founder and CEO lionized by the wags in Silicon Valley and the wallets on Sand Hill Road. A technology-enabled service that most people don’t understand, riding the waves of a boom-and-bust ecosystem. And, at the center of it all, an opaque black box with virtually no outside oversight.
As congressional inquiries heat up, this chorus of critics will demand strong new regulations that protect consumers. And clearly, after a collapse that wiped out more than $152 billion in market value for the largest cryptocurrencies, we need more regulatory oversight of the field, especially for the least savvy and wealthy in society.
Yet, establishing heavy-handed controls without fully understanding the nature of the broader crypto ecosystem and its potential benefits will choke off innovation that could produce a more equitable, efficient, integrated and transparent global economy. As lawmakers consider new regulations, six key principles should guide their efforts.
First, they need to understand FTX was not a true crypto entity. At its core, FTX had a traditional corporate structure that, like Enron and Lehman Brothers before it, escaped crucial regulatory scrutiny. In this case, the alleged fraud occurred through money transfers to a hedge fund and withdrawals for personal use, but the business model itself was essentially the same as traditional currency or stock trading platforms.
A knee-jerk crackdown on new technologies, such as the blockchains at the core of many new crypto services, will not prevent this sort of illicit activity. In fact, because the data in the blockchain ledgers are public, they might provide easier ways for regulators to audit financial flows, even if the recipients and senders remain anonymous.
Second, we need to stop lumping the broad array of promising cryptocurrency technologies together. Building guardrails around Bitcoin and other cryptocurrencies — such as monitors on custody, liquidity and “know your customer” standards for certain types of exchanges — can help protect users without stifling innovation in other applications, such as borrowing and lending.
Third, and similarly, we need to keep in mind that “crypto” is shorthand for a broader Web3 ecosystem, which contains far more than digital financial coins and exchanges. New blockchain-based micro-finance applications can extend credit to unbanked people, peer-to-peer music sharing can provide new outlets for artists, and a blockchain-based web could help to secure freedom from censorship. This wider potential of crypto technologies is what we must keep in mind when we begin to draft regulatory controls. It’s important that we protect the public from harm, but also that we take advantage of the unique opportunities these technologies offer.
Fourth, given this vast variety of potential use cases, we need a regulatory approach that we can tailor to the many different categories of crypto services. Consider decentralized autonomous organizations (DAOs), which make governance decisions by the vote of often-anonymous members. It has no single point of contact or accountability. And while that can facilitate more democratic, accessible and fluid economic activity, the underlying mindset behind today’s financial market regulation does not even begin to contemplate this type of organizational structure. A new style of regulation will need to delineate the different types of control, ownership and governance in centralized and decentralized environments and leverage their advantages.
Fifth, as we regulate, we need to make sure we do not neglect the critical role of usability and the user experience in new systems. This might sound like a product design issue, but previous regulatory experience should underscore the importance of a smooth user experience and interface. The European Union’s data protection regulations spawned a swarm of pop-ups and legalese that users rarely bother to read or use to their benefit. If we want the positive aspects of blockchains and the crypto ecosystem to advance beyond early adopters, our evolving regulations should aim to incentivize improvement of the user experience in ways that minimize the complexity of use.
Finally, the sixth principle compels us to recognize that the decentralized nature of the crypto ecosystem means these organizations and services inherently cross jurisdictional boundaries. While some cross-border institutions, such as the Financial Action Task Force (FATF) or the Basel Accords, might serve as a useful guide or even carry some of the burden for cryptocurrency regulation, no existing organization is well-suited for other types of boundless crypto applications. We need to rethink and form new institutions better equipped to handle the new dimensions of the crypto world.
These six principles provide only a rough roadmap for the more detailed, multi-stakeholder process we need, but the moment for this type of smart regulation is now. According to the Crypto Regulation Tracker of the Atlantic Council, 88 percent of the countries it studied were in the process of making substantial changes to their regulatory framework.
We cannot take a one-size-fits-all approach to crypto regulation — the nature, reach and potential of this ecosystem are too broad and too promising to suffocate with ham-fisted rules. Done thoughtfully, though, the inclination toward more regulation could take us to a higher level of economic inclusion and vitality.
Olaf J. Groth Ph.D. is CEO of Cambrian Futures, professional faculty at the University of California Berkeley Haas Business School, professor of practice at Hult International Business School, and the author of “Solomon’s Code” and the forthcoming “Great Remobilization: Strategies & Designs for A Smarter World” (MIT Press).
Tobias Straube is vice president of analysis at Cambrian, a board member at Digital Waves, the founder of Scio Network and an assistant instructor at the UC Berkeley Executive Education.
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