The uncertain policy and currency implications of Blockchain and Cryptocurrency on society
Disraeli Smith
It’s 2018, and there is uncertainty everywhere. Trust in government remains at historical lows while worries about automation are at historical highs. The public is mixed on whether financial institutions are regulated too much. What do three surveys, all in a post-Trump era, covering the intersection of business, technology and government, have to do with each other? Over the past several years, there has been a significant rise in the use of cryptocurrency (particularly Bitcoin but others also) and the technology behind it, blockchain. This rise is significant—CoinMarketCap noted the market value of cryptocurrency was $600 billion at the end of 2017, [OP1] a significant rise from $16 billion at the beginning of the year. Given this rise, both the financial industry and governments around the world are nervous about cryptocurrency (“crypto”) and its potential to disrupt currency markets and operational controls to monitor against fraud, terrorist financing and money laundering. This nervousness suggests that crypto has no chance of toppling the dollar. However, the technology behind crypto – blockchain – has the potential to change payment systems, supply chains and provide additional security for private information. As a result, policy makers should adjust their viewpoints to be more collaborative with the industry versus reactive to change.
Blockchain, per experts, is defined as “a disruptive technology platform that uses cryptography and a distributed messaging protocol to create a shared ledger between trading counterparties to execute simple transfer of asset ownership or more complex transactions using ‘smart contracts’. The data on the ledger is pervasive and persistent and creates a reliable ‘transaction cloud’ as that transaction data cannot be lost or corrupted by any of the participants.” In short, blockchain is technology that allows the transmission of data between identified parties. Accenture notes that blockchain is excellent at two things. First, all parties will have a single version of the facts with the same visibility, history and no single points of failure. Second, transactions are made and tracked as permanent digital tokens with verifiable ownership details.
As an emerging technology, blockchain has the potential to inspire new business opportunities, increase efficiencies, decentralize pricing structures and increase transparency and privacy. As recently noted in a Wall Street Journal article, blockchain’s long term potential resides in trust among transacting parties. This trust is due to the security involved. Blockchain network users have access rights that allow information to only be shared on a need-to-know basis versus today’s systems that give access to all information once credentialed. Also, transactions must be validated by every involved party to be executed. They are additionally recorded and cannot be deleted. Given its robust security, as parties become more aware and trusting, adoption will increase. A recent report by Netscribes Inc. found that the global blockchain technology market size is expected to reach nearly $14 billion by 2022, with a compound annual growth rate of 42.8 percent. Technology spending on blockchain is also expected to rise. There are significant challenges around regulation and scalability that can be addressed with the cooperation of both business and technology.
Currently, blockchain is most commonly deployed in the cryptocurrency market. A cryptocurrency is defined as “a token on a distributed consensus ledger (DCL) that represents a medium of exchange and a unit of account. A cryptocurrency can be obtained, stored, accessed and transacted electronically. It facilitates peer-to-peer exchange without necessarily going through a third-party intermediary.” Key cryptocurrencies include Bitcoin, Bitcoin cash, Ethereum, Ripple and Litecoin. Each of these cryptocurrencies use blockchain to distribute their tokens from peer to peer. In short, cryptocurrency is one blockchain use case, although probably the most commonly known use case due to the emergence of Bitcoin.
Cryptocurrency is fundamentally different than traditional banking and its rise has resulted in much uncertainty globally. Today’s banking system utilizes country central banks and commercial banks to circulate currency. The funds are owned by both those banks and the Central Bank that governs it. Banks make loans off the money that is deposited to circulate those funds into the market and in turn make money off the interest rates of those loans. This system has persisted for over 100 years of modern banking. Cryptocurrency cuts out the banks entirely, as the person who has control of the currency owns the money. Thus, using cryptocurrency, countries could theoretically deal directly with consumers rather than through banks. The below diagram dictates the difference between the flow of currency today versus with the flow with cryptocurrency.
The banking industry has been traditionally slow to introduce changes in their business model. It was slow to incorporate mobile payments but responded, adapted and created their own (Chase Pay, Zelle) in the face of Venmo and Square Cash taking market share. While the banking industry is wary of cryptocurrency, they are looking at blockchain as an avenue to quicken their payment systems. For example, one system the banking industry is looking at is Ripple. Ripple allows banks and payment processors to settle payments in real time (versus several days). It is blockchain technology that allows for cross-border payments, lower costs, and delivers real time certainty for settlements. Ripple is designed to comply with risk, privacy, and compliance requirements within existing infrastructure.
Key individuals share the industry’s hesitation towards cryptocurrency. Jamie Dimon, CEO of JP Morgan Chase (the largest financial institution in the United States), once said that “you’re wasting your time [with Bitcoin]. There will be no currency that gets around government controls.” Warren Buffett recently said “In terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending." Realizing the uphill battle that cryptocurrency faces, the financial industry is not worried about the impact to their business model. However, they are looking at blockchain as a supplement to their core business functions as an efficiency and cost improvement.
Because the financial industry is heavily regulated globally, the adoption of blockchain or cryptocurrency within the industry depends on government acceptance and action. However, governments can be slow and may not understand the environment these technologies operate in. Congressman Patrick McHenry said in 2016 about financial technology (“fintech,” the policy area where cryptocurrency and blockchain sits), “This is not the traditional debate, and the solutions aren’t your traditional solutions. It’s not more or less government, higher or lower regulatory burdens— it’s about how regulators adapt and change to meet what is true and existent, and the utilization of technology to protect consumers.” For blockchain to be adopted at rates researchers are projecting, government regulators will have to partner with business.
Despite this advice, many governments’ reactions have been to either restrict or probe cryptocurrency. For example, the Securities and Exchange Commission (SEC) has recently launched a Cryptocurrency Probe, South Korea is considering banning cryptocurrency exchanges entirely, and both Japan and Australia launched extensive regulations for cryptocurrency in 2017. These actions imply that governments so far do not understand what they are truly dealing with. Congressman Patrick McHenry continued to say “are very few members of the House, very few members of the Senate that understand [blockchain or Bitcoin]. Or that invest the time to have some level of understanding.” As technology continues to advance, government remains one step behind. Instead of understanding, governments are simply putting up barriers to further adoption. This means, for the time being, both the conventional finance industry and government are aligned in their resistance to cryptocurrency. Specifically, they hold that cryptocurrency is not a viable path forward today, and significant risks exist within anti-money laundering, tax evasion and terrorist financing. These risks are due to the benefits of the technology. For example, because the transaction details are only between the participating parties, it is hard for existing monitoring systems to pick up on true purpose of the transaction. That would allow criminals to launder money within the banking system via cryptocurrency, and then simply convert it to cash. To resolve, a collaborative partnership with complete understanding is needed.
Despite some resistance, blockchain has the potential to significantly influence society. Corporations in industries throughout the world to use blockchain to upgrade technology systems, similar to how the cloud was adopted. Recently, the Wall Street Journal noted that blockchain has the potential to lead to “new business processes, new ways to charge for services, disruptive startups and new divisions within existing companies and an ecosystem of supporting technologies.” Blockchain has legitimate use cases outside of payments to include supply chain, asset management, customer loyalty programs, media and entertainment smart meters in utilities and more. Blockchain could even change government—Dubai has announced that they want to be a block-chain powered city by 2020 and that has the potential to speed up all sorts of transactions. Other government related use cases include Visas/IDs, voting, permits/licenses, vehicle registration, credit bureau, immigration tracking, record keeping and more.
Blockchain has the potential to be a game-changer by speeding up validation and verification steps and eliminating many dependencies, constraints and inefficiencies that companies and governments face today. Ginni Rometty stated that “What the internet did for communications, blockchain will do for trusted transactions.” That said, it also creates a policy concern. Several studies note that the United States is behind the U.K., EU, Singapore and Australia in terms of fintech innovation largely due to an antiquated regulatory environment. For example, the U.K. has a testing ground where they work collaboratively with companies to innovate and improve their products so that they comply with local regulations. The results are striking—90 percent of companies that participated are expected to go to market with their products, and 40 percent of those received additional investment due to more regulatory certainty. The European Union is considering an approach that does not stifle innovation and drive corporation between regulators and businesses. Australia has an innovation hub for companies and a partnership with Britain that facilitates the entry of companies into each other markets. Legislation such as the Financial Services Innovation Act in the United States would be a good first step towards catching up to other countries. A second step would be U.S. regulators (such as the Federal Reserve) supporting innovation rather than inhibiting.
Instead of building more regulation, the U.S. should model itself after the U.K. and Australia to ensure we have an environment that does the following:
- Allow the brightest entrepreneurial leaders the ability to test and design products that will benefit the American consumer in a manner that will provide the appropriate regulatory review without enforcing burdening and needless regulations
- Provide regulators the ability to collaborate with companies in understanding the key changes within the industry and ensure that any risks to consumers and the health of the financial services industry can be corrected and mitigated
- Partner with other countries to ensure innovation does not impact the global industry and gather information about trends and tactics
The U.K. has shown that this type of environment that spurs collaboration between business and government on innovate products promotes competition, ensures financial stability and consumer protections and improves the economy due to greater private investment. The United States should be looking to do the same, and the impact would be greater due to the larger size of our economy. Our financial and regulatory system is set up so that cryptocurrency does not topple the dollar. However, the worries about cryptocurrency being used by bad actors require regulators and businesses to ensure the continued strength of our financial sectors. This said, our financial and regulatory system can use blockchain to make itself better long term and drive economic growth from further innovation. Blockchain, not cryptocurrency, is where the focus should be.
