There is growing concern among blockchain companies and investors that compliance with tighter regulations could hurt the industry. It is certainly possible that regulators rushing to increase transparency and compliance will impose non-compliance requirements on crypto companies.
It’s not only once that we’ve seen the apocalyptic view that if we don’t manage to address this conundrum, the blockchain business will collapse and China’s economic advantage will further increase.
Such a view is good for Clickbait, but unrealistic. In fact, it is quite possible that the crypto asset ecosystem will dramatically transform compliance for the better.
Discussions that have been repeated for 20 years
The Internet is already very complex, highly decentralized, and offers a very good model for dealing with compliance in a global environment. Over the last two decades, we’ve been arguing about how in-depth we should be, for example, content verification and piracy measures.
No Internet-destroying catastrophe scenario became a reality, nor did the media and entertainment industry be destroyed by a piracy storm.
The first element of a regulatory approach that can be borrowed from the Internet is the idea of implementing compliance at the boundaries of the network. Companies involved in on-ramping or off-ramping ecosystems are the best place to start compliance rules around KYC (customer verification) and anti-money laundering (AML).
In the world of crypto assets, banks and exchanges play the role of Internet service providers and content distributors. Due to their size and sophistication, they are good targets for regulators, but they can also carry out processes and digitize on a large scale.
A decentralized model for identity and eligibility verification can also be borrowed from the public internet. Security certificates are used by almost every website and every e-commerce system. Such a certificate effectively represents a kind of confirmed identity. Certificates are not enforced and are managed in a distributed model where certificates are provided by multiple providers.
Of course, it’s difficult to do business without a certificate, but in most countries you can choose a certificate provider. There is no reason why you can’t use this same infrastructure to issue identity tokens or accredited investor tokens that can be stored in your blockchain wallet.
Finally, compliance rules can be written to smart contracts.
In fact, this effort has already begun. EY (Ernst & Young) has developed an option to allow or block addresses and participants for the privacy technology “Nightfall” donated to the public domain.
A more sophisticated approach should continue, such as executing a transaction only if both parties authenticate the identity token in the wallet provided by the authorized provider. This makes it possible to check compliance without centrally controlling individual transactions.
The appearance of the net far from the ideal of the 90’s
The challenge here will be to strike a balance between compliance and simplicity. The more code and complexity you have, the greater the risk of exploiting security weaknesses and errors.
The regulatory balance that exists on the Internet is neither elegant nor simple, nor is it born smoothly. The current Internet is far from the ideal, unified global network of the early 1990s.
State regulations, firewalls, IP-based geofences and other tools have broken the feeling of endless connections in the early days. Despite these restrictions, in most parts of the world, there is still no single omnipotent administrator who can block businesses and ideas from accessing the network. The Internet remains largely an unauthorized network.
This is the most important factor that makes the Internet an incubator of innovation, and it is also the most important to maintain as it matures the regulation of the blockchain ecosystem. Many services that we take for granted every day have emerged on the Internet, despite fierce opposition from existing industry players.
Destructive service created against the rules
From ride-sharing to audio streaming to IP phones, these businesses are not only disruptive, but at least in some contexts, users when they sign up for law or at least Internet services. It can also be said that it violates some of the rules agreed upon by.
Due to the decentralized and decentralized nature of the Internet itself, there was no single regulator or organization to grant or deny such startups to operate. Instead, various steps had to be taken to oppose a particular company.
In most cases, startups had time to settle down and prove their worth. As a result, a regulatory ecosystem that balances the interests of the general public with those services with the interests of existing businesses has gradually matured.
To put it very simply, the difference between authorized and unauthorized systems is whether you’re crushing a service that’s just an idea, or a service that already has millions of users.
The difference is that ride-sharing is crushed at the conceptual stage before it has millions of users who think it’s better than a taxi. The same is true for decentralized finance (DeFi) and the blockchain financial ecosystem. Due to Ethereum’s unlicensed nature, DeFi vessels have already departed. Regulators may be restrained, but it will be difficult to crush them completely.
That does not mean that once established services are completely free from regulatory oversight. Any regulation will be introduced in the context of public debate about the benefits compared to costs. Regulators will be keenly aware of the millions of users who are at risk of getting angry if they tighten too tightly.
Risk and reward
I anticipate two major risks to the delicate balance needed to drive compliance without a significant negative impact on the industry. First, very smart companies clash with regulators struggling to keep up with emerging technologies. What happens when a company first submits mathematical proof as proof of compliance?
If only authorized persons have to show that they have participated in the transaction, it is possible to generate mathematical proof without revealing the identity of any participant. Even if such a submission is submitted, no regulator is yet ready to receive and respond to it, and even if it does not mean the law literally, it does not comply with its purpose intentionally “too clever”. It may be interpreted as a movement.
Another major risk is regulatory captivity. Regulations on the KYC and AML are widely known to be complex, expensive and ineffective. Still, one reason it remains is that existing financial services companies know that regulatory complexity poses a major barrier to competitors. The growth of the DeFi ecosystem can be dramatically slowed down by the influx of complex regulations and implementation instructions.
It was easy to crush the napster
There is one decisive force against such risks. It’s difficult to crush a decentralized system. Ask the Recording Industry Association of America. Compared to the 1990s, today’s music streaming services are a miracle. My kids will never experience the horror of having to buy an entire album just to listen to one great song.
You’ll never record a song from the radio on tape. Without a fully and properly decentralized data network, BitTorrent, this situation wouldn’t have happened.
It was easy to crush Napster, the originator of streaming services. It wasn’t very decentralized. BitTorrent was, and still is, decentralized. If you really want to steal music, you can still do it, and you can do it with BitTorrent.
Why aren’t more people bothering to do that? That’s because most people will suffice if they have the opportunity to pay for an affordable streaming service (which manages digital rights very well and is barely noticeable).
The reason why we think that the same regulatory balance in the world of digital entertainment will be created in the future for DeFi and will not lead to a wide variety of services that are far superior to those currently in use. Absent.
Like the Internet, it can sometimes feel a bit cramped compared to the truly open ecosystem we are enjoying now. But hopefully, it will be an ecosystem that is cheap, effective, automatic, and almost invisible to most users.
Paul Brody: EY (Ernst & Young) Global Blockchain Leader.
* The views are personal to the author and do not necessarily reflect the views of EY and its affiliates.
｜ Translation / Editing: Akiko Yamaguchi, Shigeru Sato
｜ Image: Shutterstock
｜ Original: Don’t Fear the Coming Regulation Wave