Due the rapid growth of blockchain technology, and its potential to disrupt almost every industry, governments throughout the world are making efforts to understand the technology and make sure that their countries strike an appropriate balance between allowing for continued innovation and protecting their citizens. Despite the United States’ role as a leader in most technology industries, the federal government has been noticeably slow in enacting meaningful legislation in this area. Apart from the IRS issuing a vague and much-criticized directive classifying virtual currency as property in 2014, there has been no federally-issued guidance or regulation that expressly governs the activities of virtual currency or blockchain companies. A glaring example of the federal government’s lax attitude is the complete lack of response by the Securities and Exchange Commission to Initial Coin Offerings. This year alone, multiple companies have raised millions of dollars through ICOs, a significant portion of which undoubtedly came from U.S.-based investors, without any SEC oversight. Moreover, the federal government has left regulation of money transmitters to the states, which has resulted in the promulgation of inconsistent licensing regimes. In contrast, in order to foster blockchain innovation, many other countries have created regulatory sandboxes and passed legislation to allow blockchain companies to test their products and operate without the uncertainty inherent in an unregulated environment.
A regulatory sandbox allows companies to test their products with small groups of users in an environment controlled by the government. This allows those companies to demonstrate their ability to comply with existing laws, without the fear of government action if they run afoul of those laws in the testing phase. For example, in February 2017, the Canadian Securities Administrators (CSA”) launched a Regulatory Sandbox Initiative “to facilitate the ability of those businesses to use innovative products, services and applications all across Canada, while ensuring appropriate investor protection.” To ensure a cohesive approach and allow for continued innovation while protecting consumers, the CSA stated that it “will consider applications, including for time-limited registrations, on a coordinated and flexible basis to provide a harmonized approach throughout Canada for business models, whether they are start-ups or incumbents.” This proactive approach will allow “cryptocurrency or distributed ledger technology based ventures” to focus on developing their use cases in a safe and welcoming environment.
In Switzerland, the Federal Council has similarly proposed the creation of “an innovation area” or sandbox, which exempts companies from having to obtain banking licenses if accepting less than one million Swiss francs ($1 million) in client deposits. While the Swiss government is currently limiting its focus to fintech and banking, its acknowledgement of the technology and willingness to allow businesses the opportunity to develop new ideas is notable. Several other countries, including Hong Kong and the United Kingdom, have also implemented similar types of sandboxes that allow “businesses to test innovative products, services, business models and delivery mechanisms in a live environment.” Even the tiny island nation of Mauritius has recently announced a Regulatory Sandbox License, which “offers the possibility for an investor to conduct a business activity for which there exists no legal framework, or adequate provisions under existing legislation in Mauritius.” The license will be issued by the Board of Investment to “eligible companies willing to invest in innovative projects according to an agreed set of terms and conditions for a defined period.”
In contrast to the above examples, an effort to establish a regulatory sandbox in the U.S. never got off the ground. In 2016, Representative Patrick McHenry (R-N.C.) introduced H.R. 6118 to promote innovation in financial services. The bill directed the “Federal Reserve and 11 other regulatory agencies to set up offices to encourage innovation and outlines a mechanism for financial technology companies to propose tests of products or services that would not be subject to certain regulations the companies view as overly confining and outmoded. The tests would be subject to limitations on their duration and extent, and would include protections for consumers and financial systems.” However, Federal Reserve Governor Lael Brainard “doused the idea of the agency setting up a regulation-light ‘sandbox’ for the testing of blockchain applications in the banking sector, [stating] that the technology is ‘immature.’”
In addition to allowing blockchain-based businesses to develop their uses cases without burdensome or uncertain regulatory environments, many other governments have realized the various ways in which blockchain technology can make traditional government functions more transparent and efficient, and have introduced/passed laws to protect consumers and increase confidence in the technology. For example, in 2016, Japan’s national legislative body, the National Diet, enacted a bill requiring virtual currency exchange operators to register with the Financial Services Agency, which the virtual currency/blockchain community welcomed as they believed it would “improve trust in the industry and virtual currencies … [and] firms, including big conservative Japanese firms, [would] enter the market to energize the industry and facilitate the use of cryptocurrencies.” The bill defines virtual currency and includes “measures against terrorist financing, including increased monitoring of virtual currencies and other new financial settlement methods.” While members of Congress have launched a blockchain caucus and introduced legislation related to blockchain technology, the federal government appears to be far away from enacting any meaningful blockchain legislation.
We are already seeing the impact of the U.S.’s hands-off approach in this rapidly developing ecosystem. American businesses are looking abroad to develop their use cases, where the fintech environment is much friendlier. For example, exchange and clearing house operator Nasdaq Inc. completed a successful test using blockchain technology to run proxy voting in Estonia, because according to its co-President, Hans-Ole Jochumsen, “there is a government that is very keen to use technology.”
In contrast to countries that are embracing blockchain technology/virtual currency innovation, in the U.S., a wide-range of virtual currency-related businesses are treated as money transmitters under state law and are therefore required to dedicate substantial capital to comply with state money transmission business license regulations requirements. In comparison, companies in this industry can obtain a single license in the European Union and operate in all 28 countries. An inconsistent state regulatory system has undoubtedly led to a US virtual currency/blockchain brain drain in which “75% of investment funds in the blockchain ecosystem come from the US,” yet much of the product development occurs abroad. The recent rise of Crypto Valley, the latest example of lost American opportunity, is likely to become a magnet for blockchain startups. Located in Switzerland between Zurich and Zug, Crypto Valley “boasts progressive laws, a competitive hiring environment and low taxes, attracted entrepreneurs looking for a place to gain traction amid an uncertain international legal climate.”
Based on the investment and interest of both the public and private sector, the blockchain/cryptocurrency industry is undoubtedly here to stay. It is in the best interest of the U.S. federal government to swiftly reconsider its current hands-off approach and create a fintech-friendly environment that draws new innovation and use cases while still protecting consumers. Rather than seeing virtual currency and blockchain technology as a threat to its current laws and infrastructure, the federal government must take action by continuing to build alliances with those already working within the ecosystem and looking to its neighbors for regulatory guidance, while still allowing businesses some elbow room to develop and innovate instead of inundating them with burdensome regulation.