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When It Comes To Cryptocurrencies And The SEC, Decentralization Is Key

The SEC’s increasingly favorable posture towards decentralized cryptocurrencies, such as Bitcoin and Ether, signals that a bellwether regulatory regime is emerging and with it a pathway for broader institutional adoption. This favorable view on decentralized cryptocurrencies does not necessarily reduce the risk in the asset class, as cryptocurrencies have the highest implied volatility of any asset around – especially during these years of growing pains. It does, however, suggest the entrance of institutional investors with decidedly steadier hands is nigh, due in no small measure to growing regulatory clarity. These investors will invariably bring better controls than the early adopter crypto-speculators that are fueling the roller coaster ride, but who have been essential in their commitments to “hodling” and moon landings in making cryptocurrencies more of a mainstream bet.

This regulatory view on decentralization also signals the permanence of certain cryptocurrencies, noting that the field of newly minted tokens and coins is crowded, with more than 1,600 floating around the ether. This is true despite the growing wave of scandals and cases of fraud largely associated with smoke and mirror initial coin offerings (ICOs). In guarding against these risks, the SEC has turned to humor in its vigilance, mounting a fake ICO website as a part of its educational arsenal. The acknowledgment that Ether and Bitcoin are outside of the reach of manipulation by any one party is something that is widely known to early adopters, but not mirrored in other cryptocurrencies. Despite some academic arguments to the contrary, what drives price volatility in Ether and Bitcoin is now more akin to regular market forces of supply, demand, price signaling and dominant players moving capital, all conditions that exist in the regular, analog economy. Perhaps unsurprisingly, decentralized cryptocurrencies have gained a new adversary in the Bank of International Settlements, which has issued a new report damning cryptocurrencies by making the outlandish suggestion they could “break the internet.” This report negates the fact that Moore’s Law and innovations such as the lightning network, computational advances and improvements in energy efficiency will accelerate transaction volumes, processing power and lower energy consumption. In short, cryptocurrencies are here to stay, and blockchain-based business models are mounting serious assaults on incumbent players.

The SEC’s posture also signals the likely development and adoption of regulatory platforms across other sectors, such as insurance, pension funds, and other heavily regulated industries. While we are far from a model law or regulatory regime, the concept of “sand boxes” and favorable jurisdictions, such as Bermuda, gives clear indications on how entrepreneurs, developers and established players can structure their blockchain and cryptocurrency projects. While incumbents are most threatened by the true power of blockchain-based business models, which thrive on decentralized consensus-based trust and the concept of self-sovereignty, challengers abound, and they would be wise not to turn a blind eye to regulators. This also sends a strong signal to would-be entrepreneurs and developers about how they should go about structuring their solutions. In short, when it comes to financial services a more decentralized and autonomous structure may receive a regulatory blessing not enjoyed by centralized alternatives. This also means startup teams will have to get comfortable with concept of ceding control, which is just another area where blockchain requires the suspension of disbelief.

The challenge with all genuinely new, category defying innovations, of which cryptocurrencies and blockchain are a part, is that players who thrive under status quo try to define the innovation in ways that conform to known conditions. Efforts to pigeonhole cryptocurrencies and many of the emerging business models native to blockchain into traditional categories is a futile exercise. Meanwhile, ignoring the rise of blockchain and its possible disruptions is tantamount to print media ignoring the perils and opportunities of the internet age. Incumbents would do well in remembering that the internet created a world of low-friction communication, while blockchain is creating a world of low-friction (high-trust) value transfer. While blockchain remains at the crest of the hype cycle, the game of regulatory cat and mouse will continue. Much like the internet before it – often likened to the first of the foundational technologies, with blockchain being the second – when the technology fades to the background, it will begin to truly change the world. In the meantime, we can expect more regulatory action, more fervor and many more opportunities at defying markets and redefining them. Surely the SEC’s emerging clarity may accelerate the number of blockchain billionaires.

As with all new industries that are moving faster than regulation, the most successful leaders collaborate with regulators to help define how regulation can evolve without stymieing innovation, while at the same time protecting the public from potential risks. With so much of the talent and capital surrounding cryptocurrencies and blockchain developments sheltering outside of the U.S., forward leaning regulations that could turn the entire U.S. market into an innovation sandbox will only improve U.S. competitiveness, investment flows, and long-term outcomes for the market. Insurance, as just one example in the financial services world, is regulated the state level, which creates a high barrier to entry and a lot of regulatory friction adding to cost and pernicious rates of under-insurance. This alone is sufficient to scare away some of the more innovative technology startups, lest they run the risk of falling afoul of the rules. So as the SEC moves from a posture of investors beware, to a posture of regulatory clarity around decentralized cryptocurrencies, new entrants to the ICO mania should know that a security by any other name is still a security.

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