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On June 5, leaders from government and industry will gather for the annual non-profit ACT-IAC Emerging Technology Forum in Washington, DC. A lineup of state, federal and international leaders will share insights about blockchain technology, both regarding government adoption of it and government regulation of the private sector’s use of it. The event is free of charge for registered government employees. Here’s a brief primer.
The Stand-Out Use Case
Since last year’s event, the stand-out area for the advancement of blockchain technology has been “track-and-trace” applications. Private industry has been using blockchain-based systems to track food provenance and supply chains for a few years already, but federal regulators are now joining the fray. The Department of Health and Human Services is using one for purchasing. The USDA recently approved one for its Process Verified Program for beef. The FDA is exploring one for pharmaceutical supply chains, as is the Department of Defense for resource management.
Is Identity Yet Ripe for Blockchain?
Hype remains ahead of reality for one use case for blockchains by governments: identity. Many are optimistic that blockchain technology can provide secure, immutable, self-sovereign identity credentials, but progress has been slow. That said, during the past year some key government projects were unveiled in this area. Zug, Switzerland has been using uPort to enable residents to register their identities on the Ethereum blockchain, and Microsoft recently announced Ion, a project built on top of the Bitcoin blockchain that can be integrated with its enterprise platforms. Bermuda has been promoting creation of an interoperable, blockchain-based identity standard for know-your-customer and anti-money-laundering compliance that would be accepted globally.
States Continue To Be Living Laboratories
States remain active in deploying blockchain-based platforms. Delaware’s long-awaited project for registering corporate stock ledgers on a permissioned blockchain recently moved to the pilot stage. The county clerk of Teton County, Wyoming chose a permissionless blockchain for recording land titles. And one state has led in the use of blockchain for the most basic of government services: voting. West Virginia successfully completed a blockchain-based pilot to allow veterans & overseas citizens to vote in the 2018 midterm election. The project started with two counties and will expand to other counties in the 2020 election. Denver used the same platform for its municipal election earlier this month.
Financial Services: Rise of A Parallel System Amid Major Regulatory Hurdles
The legacy financial services industry has been slow to adopt blockchain technology, but a large, new, blockchain-based financial sector has rapidly arisen instead. Regulatory ambiguity is both a cause and effect of the meteoric rise of this parallel financial system--meteoric because it only took a only few years for several of these new financial institutions to exceed the number of active users served by the biggest legacy financial companies.
This parallel financial system is dominated by companies that are not household names-- Coinbase, Binance, Bitfinex, Kraken, Gemini and others, some of which are already “unicorns” (companies worth at least $1 billion). The U.S. leads but does not dominate this field.
There is little cross-over between this new breed of financial institution and legacy financial institutions. The new breed is a lot more nimble, and the best example of this is the race to create a US-dollar proxy (a “stablecoin”) that can settle near-instantaneously on a blockchain, in order to cut the cost, latency and counterparty risk inherent to legacy payment systems. Legacy banks began a “utility settlement coin” project in 2015, but regulatory hurdles slowed its progress. Meanwhile, the new financial system didn’t wait and quickly created its own version, Tether, which became a liquid staple in these markets and recently topped bitcoin's trading volume. Though Tether has encountered a variety of problems, regulated versions of it have since proliferated--issued by companies in the parallel financial system that submitted to regulation and issued approved products.
The success of the parallel system has prompted some legacy financial institutions, such as Fidelity and the New York Stock Exchange, to create new affiliates that are building businesses around this new asset class. Regulatory approvals for legacy institutions have, however, been slow.
This flurry of activity in the parallel financial system has revealed several regulatory fault lines.
U.S. versus International: The global, decentralized nature of blockchain protocols poses a challenge for national enforcement efforts everywhere. A clear fault line is emerging around the Financial Action Task Force (FATF), which is expected to release an “Interpretive Note” applicable to cryptocurrency businesses and users by the end of this month. Many observers have raised concerns that compliance with FATF guidelines may not be possible in light of how permissionless blockchain protocols work (i.e., there’s no way to require the Bitcoin or Ethereum blockchain platforms, for example, to embed data about the sender and receiver in each transaction).
Federal versus Federal: Cryptoassets do not fall neatly within existing regulatory lines, which raises the question: which is the appropriate federal regulator for cryptoassets--the SEC, the CFTC, the FTC, CFPB, OCC, FinCEN or some combination? In the vacuum, most have presumed that the SEC is the primary regulator. But at its FinTech Forum on Friday, the SEC made clear it does not favor broker/dealers handling digital assets that are not securities (such as bitcoin). So, if the SEC isn’t the federal regulator for such assets, who (if anyone) is? And for digital assets that are designed to be consumed, do public-company level disclosure requirements make sense? And what if brokerage firms choose not to build the technology integration needed to service blockchain versions of securities--doesn’t that give legacy firms an unfair blocking right over this new technology? And why has FINRA, the self-regulatory organization, been slow to approve broker-dealer involvement with blockchain versions of securities? Congressional action is likely needed to clarify these issues.
State versus Federal: Digital scarcity is a new concept that poses a major challenge for existing legal regimes: Are digital collectibles personal property or securities? It is well-established that the federal government has supremacy over securities, as the Supreme Court ruled in Howey in 1946. It is also well-established that states define what personal property is (e.g., the Uniform Commercial Code is state law). Accordingly, attempts at federal preemption of state property laws could be mired in litigation for as long as it took Howey to wind its way through the courts (namely, the federal jurisdiction granted by the 1933 Securities Act didn’t become settled law until the 1946 Howey decision). Strap in, because it might take years to determine the state / federal jurisdiction of blockchain regulation. Meanwhile, as the US is sorting out its jurisdiction issues, other countries may grab the lead in blockchain.
To say the least, June 5 should make for a thought-provoking event. I look forward to hosting a lively discussion about state-level activities, focusing especially on advancements being made by secretaries of state. Government employees may register to attend here.
