The difference between cryptocurrencies and cryptotechnologies
Our internal and external debates about regulation will improve if we think of cryptocurrencies as two ecosystems rather than one. There is a basic dichotomy that has a big impact on the policy debate that explains where we are in regulation today and will determine how we move forward. But we never talked about it, and it's time for a change.
One aspect of cryptocurrencies is primarily about investment. They call it a "cryptocurrency." Essentially, it's about buying, holding, lending, and trading tokens as investable assets. Cryptocurrencies want big institutions and pension funds to invest, as well as spot traded products that every retail investor buys. When cryptocurrency people say, "It's early days for cryptocurrencies." That means most people haven't bought them yet, which is causing concern among regulators.
Another aspect is the establishment of peer-to-peer computer networks where participants trade by interacting with globally accessible software. Call it "encryption." Cryptography wants these new computer ecosystems to actually work and provide utility to users. When encryption people say, "It's early days for encryption," it means that many of the key technologies that define the long term have yet to be established. The required innovation is not so much directly related to price increases (but price increases are not insignificant, in part because it affects the security of these agreements). In general, regulators know little about this, but some are learning fast.
Centralized finance (CeFi) is the heart of cryptocurrencies. Intermediaries define and drive the investment landscape. In contrast, in encryption, the defining characteristic is the software acting as a counterparty or intermediary. Crypto is more of a decentralized finance than CeFi.
Cryptocurrencies and cryptotechnologies present different risks that public policy may address. In cryptocurrencies, the risks look more or less similar to those in traditional finance: escrow, third-party facilitated payments, retail investor protection, illicit financing and market manipulation, to name a few. After all, CeFi looks a lot like traditional finance (TradFi). Encryption risks include some of these categories, but also entirely different ones: the dangers of self-custody, vulnerable smart contracts, equal access for good and bad actors, and public, anonymous and irreversible transactions. DeFi opens up an entirely different set of problems, one with which public policy is unfamiliar.
The difference between cryptocurrencies and cryptotechnologies has recently become more pronounced. Recent discussions about regulatory policy between encryption OG Erik Voorhees and FTX CEO Sam Bankman-Fried often touched on this potential distinction. SBF usually provides a monetary cryptographic perspective, while Voorhees often holds the banner for technical cryptography. Vitalik Buterin chimed in on Twitter: "From a tech encryption perspective, he prefers slow investment in mass adoption if it gives the technology time to progress." Bloomberg contributor Matt Levine recently did a thorough analysis of cryptocurrencies, keenly recognizing the difference between money and technology.
That distinction is staring us in the face, and it is time we acknowledged it in the regulatory debate. Its failure to do so has thrown the industry into turmoil.
So far, cryptocurrencies have been the big gorilla in the regulatory debate. Cryptocurrencies attract wider attention, have a range of policy issues that need to be addressed more directly (for example, getting Americans to margin trade perpetual futures), contribute more to political campaigns, spend more on policy staff, lobbyists and policy advertising, and are generally more sophisticated in international, federal and national policy formulation and enforcement. As a result, cryptocurrencies have been the dominant and defining issue on the agenda. "Regulatory transparency" has been the dominant policy topic, in large part because regulation could open up a wider market for investors, not because developers want permission to write new smart contracts. Cryptocurrencies seem more willing and able to reach regulatory compromises that open up new markets for their camp, even if the compromise entails unlimited regulatory risk for crypto.
Cryptocurrencies have been driving regulatory discussion, which has led many regulators to overemphasize the investment side of encryption. Digital assets, they argue, are things to buy low and sell high.
Encryption has been relegated to the back burner, with much less visibility due to less money invested in lobbying and policymaking, less knowledge of Washington, D.C., and fewer existing regulatory issues. Most lawmakers have heard of a meme Token and its skyrocketing price, but few know that Ethereum is a computing platform and almost no one understands the protocol it's built on.
But the balance in advocacy is shifting a lot, and that should make for a more informed discussion. The shift is no accident. Regulators in the crypto space are now examining peer-to-peer networks, unmanaged wallets, smart contracts and more. The spectre of P2P(peer-to-peer) regulation is now on the horizon, so as an increasingly necessary thing, crypto is devoting more resources to policy development and advocacy.
We see this trend in the recent response to the Digital Asset Commodity Consumer Protection Act, which was considered with committees in the US House and Senate. While cryptocurrencies - particularly a fairly active major CeFi player who will remain anonymous - have been pushing for the bill's passage, crypto has been complaining that vague and vague provisions would allow the CFTC carte Blanche to regulate peer-to-peer protocols, criticisms that have put the bill's sponsors and some in the currency crypto world at a disadvantage.
As encryption begins to play a bigger role in the conversation, we should embrace both sides. There is no good or bad -- rather, the relationship is symbiotic. Most people only care about cryptocurrencies because crypto helps the price go up, and the price goes up because crypto is creating something that makes people believe that these technologies might change the world. Right now, cryptocurrencies and cryptotechnologies seem to be the same thing, which can hinder debate on policy issues.
It's also confusing for regulators, and if there's no gap between cryptocurrencies and cryptotechnologies, then it makes sense for regulators like the SEC to have the same regulatory solution in both areas.
The logic: "Because we're obviously going to regulate the investment side, we should regulate the technology side as well." Ideally, properly framing the two sides would allow agencies to behave more like FinCEN (Financial Crimes Enforcement Service) has behaved to date. The agency sees a rush to enact a rule in 2020, hoping to limit unescrow wallets and appropriately resist (to the extent they can) their bosses at the U.S. Treasury. They know that their congressional mandate extends to cryptocurrencies, which are often in the money services business, but extending regulation to crypto is beyond their purview.
A coherent approach would mean addressing the regulation of cryptocurrencies first, and then dealing with cryptography. Cryptocurrencies are more vulnerable to regulation, and while we may be far from good at it, we have experience regulating the intermediated financial system. We can and should prioritise all the messy but important details, including custody requirements, Know your customer (KYC) and balance sheet transparency, which must be addressed in CeFi. By focusing first on properly regulated CeFi, we will address the undeniable part of cryptocurrencies that is larger, more accessible to transactions, and more closely tied to TradFi.
In doing so, we can develop our views and hopefully reach a greater consensus on the risks and mitigation strategies associated with the global unlicensed P2P cryptocurrency space. This approach makes sense, in large part because DeFi is in its early days and will almost certainly evolve meaningfully over the next few years. Some of these changes will inevitably address many of the risks we see today.
When it comes to cryptocurrencies and cryptotechnologies, we should react more appropriately. Advocates should quickly mobilize to fight the folly of any law or regulation that seeks to extend the definition of a virtual Asset service provider (VASP) or crypto asset service provider (CASP) to a technology provider or platform. When we hear "DeFi and CeFi have the same rules," we should point out the flaws and the resulting inconsistent formulation of policies.
While the distinction between cryptocurrencies and cryptotechnologies is important, they exist in one another. In the short to medium term, crypto will see an influx of innovation, energy, talent due to investment interest, and these are the most important factors driving innovation. Cryptocurrencies need these technologies to win in the long run and make these tokens truly valuable. But these two aspects of encryption are not the same, and both our engagement and policy goals should reflect that.