M. Ridgway Barker co-authored this article with Joseph Bambara CIPP/US.
2020 may very well be remembered as the year in which cryptocurrency and digital assets coupled with decentralized finance took the next step towards being a mainstay of financial services. It was the year of acceptance. According to a recent Fidelity survey, 27% of institutional investors in the U.S. hold crypto-assets, and 60% of investors across the U.S. and Europe believe digital assets have a place in their investment portfolio.
Crypto prices are rising again as institutional investors warm up to the asset class. An increasing number of countries worldwide have launched or are considering the possibility of launching digital currency projects. The trend toward acceptance of digital assets as an asset class is particularly notable because of the continued uncertainty in a regulatory landscape in which the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission, with an assist from the U.S. Department of Justice, have primarily adopted an ad hoc regulation-through-enforcement approach in lieu of precise and binding rules to guide market participants. (Please see our article, Crypto Crime Enforcement Trends: The U.S. Department of Justice Steps Up).
2021: a new administration and new SEC Chief
Let's look at what has changed so far in the new administration. To begin, Gary Gensler has taken over the Securities and Exchange Commission (SEC) chief's job under the incoming Biden administration. He previously held the position of chairman of the Commodities Futures Trading Commission (CFTC). He has experience that spans Wall Street, government regulation and has even taught about cryptocurrencies and blockchain at MIT. Gensler's appointment should produce clarity for industry regulatory guardrails. Gensler has discussed the need to bring the Federal Reserve into the modern payment era. Gensler's task will be similar to his assignment at CFTC: bringing order to an unruly ecosystem. The cryptocurrency ecosystem does not yet have hefty trading volume, partially because it shares the weak regulatory walls that allow criminals and unscrupulous characters to flourish and bars the entryway to institutional and retail investors. Gensler will have to bring order to the ecosystem while preserving its potential to reshape modern finance's infrastructure.
Looking forward, we can hope that Commissioner Gensler will team up with SEC Commissioner Pierce. Pierce has argued that if the SEC decides to "steamroll the technology's liberty-enhancing features under the weight of regulation, we will lose a lot of the power of the new technology to afford opportunities to people whose autonomy has previously been curbed by limited access to the traditional financial system, geographic location, social standing, or subjection to a repressive government."
(Please see, https://www.sec.gov/news/speech/peirce-libertys-loss-2020-12-10). Pierce is known affectionately in the blockchain community as "crypto mom". Almost a year ago, she published a proposal for a three-year safe harbor for crypto projects. (Please see, Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization). The safe harbor would provide network developers with a three-year grace period to facilitate participation in and the development of a functional or decentralized network. If they do, they would be exempted from the registration provisions of the federal securities laws, so long as the conditions are met. This objective is accomplished by exempting:
- The offer and sale of tokens from the provisions of the Securities Act of 1933, other than the antifraud provisions.
- The tokens from registration under the Securities Exchange Act of 1934.
- Persons engaged in certain token transactions from the definitions of "exchange," "broker," and "dealer" under the 1934 Act.
This initiative represents the best opportunity for the industry to resolve a logjam that is stifling U.S. crypto and digital asset projects' abilities to launch new public networks. The current regulatory fog has already driven innovation and jobs to more regulatory progressive parts of the world, such as Singapore and Switzerland.
The blockchain data privacy dilemma
Perhaps the most pervasive consideration impacting blockchain's mainstream adoption even for cryptocurrencies is the notion of data privacy. It has become paramount among user concerns. Blockchain's complex relationship to data privacy is largely paradoxical for the subsequent parties:
- Users: cryptocurrency users want their transactions as discreet as other facets of their finances are.
- Governmental Entities: Governments require as much transparency as possible to combat counter-terrorism and Anti-Money Laundering.
These conflicting objectives create challenges for digital asset projects which seek to increase privacy for consumers while increasing transparency for legal compliance. As mentioned, U.S. securities laws need a refresh. They are not in tune with the disruptively accelerating digital currency adoption trend, financial decentralization, and self-regulated token offerings. Decentralized finance (DeFi) projects often feel challenged with regulations limiting what they can do. At the same time, DeFi projects find it problematic when there are no regulations to assure customers, investors, or traders that the digital assets they are getting from a decentralized financial market bear real value. Decentralization has numerous advantages, but without regulation to provide assurances to investors and consumers, it will be difficult to attract investors into trusting new financial services and security classes. Regulation and compliance build trust, which may just be what DeFi needs to gain traction in the financial community. (Please see our article, DeFi: decentralized finance is on the rise).
2021 trends in blockchain: mainstream adoption
Beyond regulatory issues and more pertinent to the enterprise is the fact that numerous developments in this space are well on their way to improving digital asset transaction speed. The currently implemented consensus methods are slow. Cloud paradigms are evolving to curtail blockchain latency. Novel solutions address its data privacy limitations, and numerous use cases clearly detail its expanding horizontal business value. These trends enable blockchain users to devote time to monetizing its advantages instead of coping with its drawbacks. The new year's most emergent Blockchain trend is the movement towards solving its scalability issues via the cloud. There are many digital asset use cases in which the scale, both horizontal and vertical, reflecting mounting numbers of users and data induces considerable latency, negatively affecting this technology's value. Organizations continue to outsource the infrastructure, maintenance, and expertise required to run it. Serverless is the most affordable form of cloud computing. It democratizes blockchain for the enterprise, from any fledgling cryptocurrency startup to established players and from subject matter experts ("SME") to enterprises focused on any business domain. Although cryptocurrencies are the most ubiquitous blockchain use case, there are many ways this technology either decreases costs or boosts profits for horizontal applications. Some of the most important use cases include:
- Regulatory Compliance: Blockchain technology can trace data from its creation through its transformations over time internally and externally between parties. It lowers costs for auditing and regulatory compliance, enabling these processes to occur remotely.
- Logistics and Supply Chain Management: The trending interoperability of blockchain combined with artificial intelligence and the internet of things is primed for providing real-time information about parts, supply chains, and logistics.
- Smart Contracts: Blockchain will virtually eliminate the administrative overhead of developing and monitoring the execution of contracts, significantly decreasing the time to act. By automating agreement and business logic in distributed settings, this aspect of blockchain will facilitate enterprises sharing their code and data across companies, regions, and clouds.
In summary, 2020 will be remembered for the pain and suffering endured by millions around the globe. However, throughout history, times like this are accompanied by periods of innovation and creativity. Digital assets that leverage blockchain technology will significantly enhance the performance of the financial system creating new opportunities for entrepreneurs. It will reduce transaction costs, increase efficiency, and strengthen compliance. Hopefully, in 2021, the growth of digital assets with advances in financial technology and the decentralized web will bring us fairness, freedom, and individual sovereignty. To get there, we must prioritize innovation.
Stay in touch with us at Withersworldwide to learn how to prepare your businesses both technically and legally to safely and efficiently incorporate these emerging technology trends. The Withers team can help their financial partners with the legal and technology expertise to stay ahead of the competition.