How to Move from Local to Global Regulation of Crypto-Assets
On July 7, 2022, the US Department of Treasury (USDT) published a fact-sheet on the regulation of digital assets (aka crypto-assets) in which it emphasized the need for global cooperation. However, this fact-sheet is only a drop in an ocean of mostly uncoordinated crypto-regulation initiatives, both domestically (eg presidential executive order, a bi-partisan bill submitted to Congress, and diligent SEC enforcement) and abroad (eg final steps toward a harmonized regulation in the EU and several declarations by individual countries).
The current wave of crypto-regulation announcements aims to eliminate the confusion that has dominated the cryptomarket since its emergence. In a recent article, however, we argue that the uncoordinated crypto-regulations are potentially counter-productive and likely to be a byproduct of two classical incentive problems. The first problem is the so-called tragedy of the commons, where shared resources are over-consumed due to the inability of consumers to exclude one another from access. Because regulators of the cryptomarket cannot exclude each other from intervening, they each take a piece, causing a potential depletion of the market’s benefits through over-regulation. The second problem is a free-rider situation: Local regulators have little incentive to develop any type of globally efficient regulation that benefits everyone, as they are mostly preoccupied with local consumers. Each regulator prefers that someone else exert the effort, ie to free-ride. We explain why the current state of affairs can include both over-regulation (legal uncertainty and conflicting rules) and under-regulation (a globally inefficient framework).
The tragedy of the commons and free-rider problems are classically solved by the government, which takes over the management of non-excludable goods. However, as the cryptomarket serves a global audience, the same logic requires that it will be globally regulated. This conclusion is consistent with the spirit of the recently published USDT’s fact-sheet:Only with international cooperation can the problems in the cryptomarket be mitigated.
In our article, we propose three approaches The first is the appointment of a centralized global regulator that will be responsible for regulating all aspects of the cryptomarket. Such an international body can be formed as a new independent regulator, or an existing regulator could be charged with the mission (eg the Financial Stability Board, the Financial Action Task Force, or some ad-hoc organization established by the G7 forum). The second is decentralized regulation involving many different countries. This approach can make sense technologically if it exploits the ability of blockchain to implement a voting mechanism. For instance, much like a ‘Decentralized Autonomous Organization’ (DAO) that uses blockchain for registering votes, key regulators from different countries can each be granted a vote and decide on new regulations. The third solution is international standards. For instance, just as the Basel Accords set standards for bank-risk regulation but let each country decide on the details, one could develop a set of principles that all countries should follow. This approach will be useful if it achieves some degree of harmonization but permits flexibility when a country face some idiosyncratic issues.
We emphasize that, to achieve any of these solutions, one needs to reduce transaction costs for international negotiations and distinguish between two applications of regulation: off-chain and on-chain. The application of off-chain regulation concerns actions, by regulators and others, outside the technology and may include, for instance, investigations, court proceedings, and drafting of guidelines. The application of on-chain regulation, conversely, concerns changes in the code itself. These changes can then either enable the creation of new rules (via voting, as mentioned) or provide an automated enforcement tool. Given the global nature of the technology and the difficulty of cross-border enforcement, an effective solution will likely require combining both on-chain and off-chain solutions.
Roee Sarel is a Professor at the Institute of Law and Economics, University of Hamburg.
Hadar Y. Jabotinsky is a blockchain and crypto-assets researcher and the founder and head of the Hadar Jabotinsky Center for Interdisciplinary Research of Financial Markets, Crises and Technology.
Israel Klein is an Assistant Professor at Ariel University.
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