Will cryptocurrency regulation promote or stifle innovation?

While the lack of regulation in the early days of blockchain helped catalyse the development of new platforms and technologies, cryptocurrency has now reached critical mass and appropriate regulation is a prerequisite for large-scale adoption by both retail and institutional investors.

Bitcoin was and still remains a grassroots technology. The network was launched as an experiment in peer-to-peer online money and slowly gained traction over several years – first as a niche interest for libertarians, cryptographers and fiat money sceptics, then later as an alternative financial asset. Since the world had never seen anything like it (in fact, many experts believed the implementation of true digital cash was impossible) it did not fit neatly into any existing regulatory frameworks.

Cambrian explosion

That remained the case for several years. The lack of regulation undoubtedly helped push the sector forwards, and the early era of blockchain saw a ‘Cambrian explosion’ of new ideas and platforms. This was an exciting period of intense and enthusiastic experimentation, with developers seeking to build ambitious and far-ranging applications from a melting-pot of new technologies. A large proportion were funded by ICOs, unregulated token sales that collectively raised many billions of dollars.

Tested in the unforgiving environment of the unregulated marketplace, it was a case of survival of the fittest. Many of the new initiatives quickly floundered; others proved their worth. Platforms that launched in this way established key developments for the industry: proof-of-stake consensus, the first smart contracts, early decentralized exchanges, robust privacy protocols, and more.

It was a time of tremendous and rapid innovation, but also one of countless scams, vapourware, overblown promises and failed initiatives. No wonder that the SEC (the US securities markets regulator), and other global regulators started to pay greater attention in the wake of the 2017 crypto and ICO boom. Cryptocurrency was on the verge of becoming a mainstream phenomenon, exposing potentially millions of consumers to unacceptable risk. It was time for regulation to catch up.

Precedent

In terms of regulation, there are parallels between cryptocurrency and other major technologies. Take flight, for example – a heavily regulated industry, for obvious reasons. But when Orville and Wilbur Wright built the first powered flying machines in their bicycle shop almost 120 years ago, they were entirely unhindered by regulation. The First World War accelerated the pace of innovation, but the Air Commerce Act wasn’t made law until 1926 – at the demand of aviation leaders themselves, who grasped that the commercial industry would not thrive without the reassurance of robust safety regulation.

Or take a more recent example, Skype – like Bitcoin, another grassroots web technology. Last year, the European Court of Justice finally ruled that some of the services provided by Skype and other similar VoIP technologies fall under telecoms regulation, following several years of legal wrangling. Had Skype’s creators sought clarification from the regulators before they launched the platform in 2003, it might never have seen the light of day. Instead, they simply released it – and had gained a million users within a year.

A framework for growth

There’s a strong case for believing that in the critical early days of a fragile new technology – whether that is powered flight, VoIP or blockchain – regulation can stifle innovation. But once those technologies are refined and hit critical mass, intelligent regulation is absolutely key to ensuring broader adoption. New technologies pose risks as well as opportunities, and consumers will be reluctant to engage unless those are addressed.

Lack of trust in the new technology and wariness of security risks are two of the main reasons cited by consumers for not using cryptocurrencies. The majority of retail investors are unlikely to use unregulated exchanges, which offer few (if any) protections. For institutional finance, the situation is more cut and dried. It’s not simply a question of caution. Institutional investors must hold customer funds with regulated custodians (typically broker-dealers and banks). Until recently, those services did not exist for bitcoin.

Imagine being a forward-thinking hedge fund manager back in 2011. You see a remarkable new financial technology: a censorship-resistant, borderless peer-to-peer digital asset that lies outside of any global political-economic structures. It’s almost unknown, trading at just a few dollars, but you realise that if it gains any degree of traction that will change, fast. It is the most asymmetric investment opportunity you have ever seen by an order of magnitude, but the rules mean your fund is simply unable to invest in it.

Regulation is therefore fundamental for the growth of the industry, but it must be intelligent regulation. The major concerns are keeping consumers safe and maintaining financial stability, and regulators are not necessarily required for this. Well-meaning but ill-conceived regulation can kill innovation.

One of the most powerful examples of required regulation, and one the crypto community has long and eagerly awaited, is the approval of a Bitcoin ETF by the SEC. While retail investors and family offices can already buy BTC from unregulated exchanges, many are understandably hesitant to do so. Private Equity and pension funds cannot purchase bitcoin due to the need for a regulated custody product. An ETF would increase confidence for small investors, enabling them to gain exposure to bitcoin as easily as buying index funds that track the FTSE, S&P 500 and other global stock markets. It would also open the door to greater institutional investment. But approval by the SEC is contingent upon – among other things – exchanges and custodial arrangements that are fit for purpose and provide adequate consumer protections.

Qredo’s role

To summarise, the lack of regulation in the early days of the cryptocurrency phenomenon doubtless catalysed innovation, enabling the rapid advances that helped the technology achieve worldwide recognition and have remained a feature ever since. But when new technologies reach critical mass and mainstream audiences, regulation is key to ensure consumer protections, confidence and further adoption.

We are very clearly now at that point. Within this fast-evolving regulatory landscape, Qredo potentially has an important role to play. By changing the paradigm for the way crypto assets are transacted and settled, Qredo’s technology offers new options for services that exchange and store funds. The unique model of multi-party computation and asset delivery removes the single point of failure inherent in traditional key-based systems, enabling new approaches to compliance and new ways of solving the problems that have plagued the industry for over a decade.

Thus Qredo enthusiastically welcomes intelligent and clear regulation for the crypto space, and looks forward to helping the architects of the new digital economy maintain compliance through our technologies.