The crypto industry is bracing itself for regulation as it nears the financial mainstream. Smart regulation and better technology for the storage of digital assets can rebuild trust in crypto and fuel growth ‒ without sacrificing the founders’ idealism and innovation.
It happens to almost every new technology. Idealistic tech libertarians create technology that upends industries and centuries-old business practices. People make a lot of money from the technology. People make grandiose claims about the technology’s potential for humans.
The technology develops rapidly. The traditional media gets excited about it. Some people make a lot of money from it. Meanwhile, there are worries about the security of the technology and how some people (criminals, hackers) are using it for nefarious activities.
A debate begins about how the technology should be regulated. The people and companies who developed the technology squabble over how it should be regulated and technological standards that would make it easier and more secure to use on a large scale. The squabbling prevents the technology from achieving its potential. Critics dismiss it as a bubble.
This is happening to the crypto industry and the blockchains it runs on. There are concerns over its security ($1.1 billion worth of cryptocurrency was stolen in the first half of 2018, according to cybersecurity company Carbon Black), it’s lack of regulation and clunky procedures for storing digital assets (cold storage) are undermining crypto’s reputation.
These worries are scaring off some institutional investors and trading exchanges.
These trust issues are ironic given that it is often described as something that can increase trust in business transactions and democratise finance and our economies.
Perhaps the biggest attraction of crypto currencies and blockchain is that (in theory) you have an indelible record of a transaction, held by all parties involved. You trust the transactions because they can’t be challenged or rejected. (Or “non-repudiation” in industry speak.)
You don’t need to trust a single financial institution, which holds the records of a transaction, because everyone involved in the transaction has their own record of the transaction, in a decentralised computer network.
This simplicity and openness of crypto/blockchain has been compared to double-entry book-keeping (whereby every financial transaction, a debit or credit, has an equal and opposite), that was invented in the late fifteenth century by a Franciscan friar and mathematician.
Crypto technology and blockchain can improve on this system, which has been universally used for more than 500 years. It can do this by creating what cryptographer Ian Grigg has described as “triple-entry book-keeping” − one entry on the debit side, another for the credit, and a third into an immutable, undisputed, shared ledger.
As traditional financial institutions enter the crypto market, how should the industry be regulated? Should the pioneers of the technology accept that regulation is inevitable and try to shape future regulations? Or fight it? How can technology restore trust in the crypto industry?
Find out more about the importance of decentralized custody in the Qredo white paper.
The debate about whether and how the crypto industry should be regulated is often heated. The matter is also complex, given the algorithmic complexity of blockchain and the different permutations of crypto networks.
Compliance heads at crypto exchanges and banks are grappling with fast-changing technology, regulatory uncertainty and suspicion over crypto and its legitimacy. Plus, there is the challenge of complying with centralised laws and rules when using a decentralised technology that was designed to be outside the financial establishment.
Legal grey areas further pile on the pressure. Take the debate over whether it should be subject to regulations for trading securities. There is disagreement about whether crypto/blockchain is a security. In the US, law enforcement and regulators use the “Howey test” to determine whether a transaction is an investment contract.
This test must be used on a case-by-case basis to each digital asset, although Jay Clayton, the chairman of the Securities and Exchange Commission, the US financial regulator, has said that every initial coin offering (ICO) he has seen is a security.
The regulation of issuing security tokens has obvious benefits – the main one being its protection of investors, particularly novice investors. Potential drawbacks of this type of regulation include potentially shrinking the investor pool for legitimate projects. However, it would also make it harder for bad or fraudulent companies to make money from digital currency and blockchain.
As with any regulation, a balance must be struck between protecting consumers and keeping businesses honest and not making the regulation so burdensome and expensive that it kills innovation and the promise of the technology.
As Casey and Vigna have warned, regulations, such as the reporting and capital requirements that the New York State Department of Financial Services’ “BitLicense” imposed on cryptocurrency remittance start-ups, become barriers to entry that protect incumbents.
There are reasons for optimism, though. Blockchain technologies such as post-quantum cryptography, distributed file systems, threshold ring signatures and isogeny-based key encapsulation, are developing fast. They may help assuage some of regulators’ concerns and even make regulating the crypto industry easier because of the transparency of each transaction.
The founders of the crypto industry, crypto companies and exchanges, can play their part in creating a safe, stable and prosperous industry. Let’s focus on what unites us (a belief in open, secure and simple business transactions) rather than often minor differences in technology and how we should be regulated.
Working on robust industry standards, such as a decentralized custody network will guarantee security, account segregation and proof of reserves. It will also improve crypto’s reputation and fuel growth.
Qredo’s technology minimises the risk of digital asset theft by generating key-less custodial wallets, so private keys are kept safe. Private keys can only be generated when the right digital signatures approving redemption requests are generated.
We don’t claim to have a monopoly on technological breakthroughs or trust, but we do think it’s a start to the debate we need.
We need smart regulation. Surely, it’s far better to help develop crypto regulations that will benefit everyone, rather than having ill-considered and heavy-handed regulations imposed on us. That would curb growth and innovation and further decrease the trust we set out to increase.