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Financial service providers have been heavily regulated and tightly supervised in most countries for decades. Banks, brokers, investment- and wealth advisors, stock- and commodity exchanges, insurance companies, and a whole range of other financial service providers, require licenses to operate, and have to follow strict codes of conduct and reporting requirements. The reason is obvious, they are “trusted intermediaries” handling large amounts of their clients’ money in transactions that are often opaque, and hard to understand and track, both for the clients and the public authorities.

The possibility not only to record data in an immutable distributed ledger, but also to record transfers of value in the form of digital currencies on a blockchain, creates the perspective of direct or “peer-to-peer” transactions that cut out these trusted intermediaries. This is appealing, in particular to sophisticated clients and to those with a higher tolerance for the risk immanent in new technology, because the trusted intermediaries not only charge significant fees for their services but have also been subject to many scandals in the past, putting question marks on the “trusted” in trusted intermediaries.

Of course, it would be naive to believe that financial markets will automatically be better off without the trusted intermediaries and that peer-to-peer transactions will effectively eliminate the problems of the past. Any market with a capitalization in excess of $2 trillion will attract its fair share of speculative investors, high-risk entrepreneurs, snake oil salesmen, and more or less organized crime. The technology behind blockchain and smart contract transactions is complex and poorly understood by the vast majority of users, yet enormous amounts of money are already being invested and transacted on a regular basis, and at least some participants have become fabulously wealthy in the process. 

This creates an ideal environment for innovation and creativity but also for fraud, tax evasion, money laundering, crime- and terrorism funding, and so on. For this very reason, regulators around the world are playing a game of catch-up with the developers and entrepreneurs in the crypto space. The crucial question is how to harness the technology, foster innovation and competition, attract high-tech jobs and services, and do so in a way that protects investors, developers, users, consumers, tax collectors, public safety, and the environment. 

The challenge is exacerbated by the fact that the technology is built on the internet and accessible to anyone, regardless of national and jurisdictional borders. Blockchains and smart contracts are governed by code and follow principles of offer and demand, whether or not these are in compliance with regulations applicable locally. 

As I have elaborated elsewhere, the ideal and indeed the only truly sensible level for regulation of this technology is the international level, for example in the form of a widely ratified and implemented convention developed and promoted by an agency such as the United Nations Commission on International Trade Law (UNCITRAL). Such a convention should provide a list of reasonable requirements to be met by anyone wanting to issue coins or tokens, wanting to provide a marketplace for trading them, or wanting to develop business solutions for investors, commercial transactions, or consumer contracts. 

The convention should also provide for a variety of oversight mechanisms calibrated to the potential risks created by the different uses of the technology, as well as one centralized agency per country with meaningful resources and investigative powers. Importantly, the convention should provide a passport system, namely that a crypto business lawfully operating in one signatory state can lawfully enter the markets in all other signatory states. The latter should only be allowed to interfere if they can show that a particular actor either obtained its licenses fraudulently from the home country or, for reasons that may be specific to the host country, poses a real and substantial danger to non-economic or public interests of the host country – e.g. the health and safety of its people, the protection of consumer financial interests, or the environment – and that those interests cannot be adequately protected by less severe restrictions or measures. 

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Last but not least, the convention should provide for a dispute settlement system that is accessible for the crypto businesses and effective, ideally along the lines of investor-state-dispute settlement (ISDS) via international arbitration. ISDS is the only dispute settlement system where a company from one country can have an effective remedy against unjustified regulatory and other measures imposed by the authorities of another country. Without a system like ISDS, the company would have to challenge the authorities in their own domestic courts and that is often not promising because of bias or undue delays or incompetence and corruption.

Of course, chances of getting such a convention and getting a sufficiently wide range of countries to ratifying and effectively applying it are basically zero, in particular as views around the globe still differ fundamentally with regard to the best way digital currencies should be managed or whether they should be allowed at all. 

In the absence of a global regulatory framework, the task falls on regulators at the national and regional level. What they should be doing is development of a coherent strategy that achieves the required safeguards while also providing legal certainty for the investors and developers and reliable information on what will be allowed, and on what conditions, in the foreseeable future. Furthermore, the national regulators should be in conversations with each other, exchange experiences, and facilitate mutual recognition of licenses granted to businesses in the blockchain space to facilitate international operations without the need – and the regulatory uncertainty – of seeking permits and registration in every country of operation. 

Unfortunately, even just a system of communication and mutual recognition is currently not in the cards. Even inside the United States, the regulators at the federal level and at the level of the several states are not really collaborating, let alone recognizing each other's licenses and permits. 

Instead, what we have is a hodgepodge or regulations. The SEC says cryptocurrencies, for the most part, are securities. The CFTC says they are commodities. The IRS says they are property. The OCC and FinCEN say they are money. The Fed says they may be money but they are not currency. Wyoming says they are welcome. New York says its BitLicense is encouraging innovation, yet everybody else says that Wall Street got the ringfence it was asking for, to keep DeFi in check.

Overall, the U.S. is a microcosm of nonsensical and mutually contradictory regulation that, unfortunately, reflects what is going on around the world. However, if we can't even develop good regulation domestically, how are we supposed to get the rest of the world to follow us into a future where beneficial uses of the technology are enabled and encouraged and harmful uses are contained and prevented?

Tech savvy lawyers definitely have their job cut out for them. At the Blockchain Law Alliance, we will encourage dialogue, cooperation, exchange of experience and information, and the development of sensible regulation.