Concerns that over-regulation can stifle innovation and hinder the growth of Web3 are valid. But proper rules and laws can equally save and supercharge crypto.
This op-ed is part of CoinDesk’s State of Crypto Week sponsored by Chainalysis. Anne-Sophie Cissey is the head of legal and compliance at Flowdesk, a Paris-based marketing-making technology company.
Regulators have in the past stifled or curbed innovation when hastily responding to unexpected events. While the contagion of FTX last year demonstrated the need for regulation that enforces transparency and customer protection, the recent rapid crackdown has lacked a cohesive framework.
In spite of that, regulatory oversight can also be a force of stability, transparency and legitimacy for emerging industries. Thus it is more important now than ever for Web3 to collaborate with regulators to ensure the future of their emerging industry. There are many compelling Web2 examples where regulation played a crucial role in strengthening the industry’s foundations.
Regulation encourages businesses to act properly, balancing privacy with financial freedom
One such example is PayPal. The company secured an alternative avenue for consumers and merchants alike to engage in financial processes without the need to set up a bank account.
Responding to regulation — PayPal went on to become one of the first successful online payment providers, transforming payment services from a private good to a public good.
This innovation came during the backdrop of intense anti-terrorism and money laundering litigation as mandated by the PATRIOT Act that sought to guarantee greater security for American citizens. The regulation changed PayPal. It obligated the company to provide a robust means through which it could prove that it properly vets its customers — while providing users with easy access to finance.
PayPal’s compliance with the legislation enabled the company to expand its services beyond the United States, too. This expansion helped to increase PayPal’s revenue and market share, while also providing greater convenience and accessibility to its users.
Similarly, regulation in crypto can encourage greater transparency by utilizing blockchain’s distributed ledger technology. We’ve seen legislation such as MiCA attempt to implement verification measures to bring Web3 in line with existing financial institutions. For example, it limits non-KYC’ed wallet addresses to 1,000 euros (~$1,057) per transaction — while KYCd addresses can transact freely. This could be considered a positive step in the right direction. Larger participants hold a greater share of the market, so, they should be held more accountable for their on-chain behavior.
Regulators could potentially embrace the role of the “superhero” by enforcing stricter liability on businesses that behave improperly. In doing so, businesses have an incentive to exceed compliance measures whilst also protecting consumers.
FINRA Rule 5310 requires broker-dealers to exercise “reasonable diligence” to ensure their customers receive the best execution when conducting trades. Robinhood has in the past been criticized for not providing sufficient risk disclosures, particularly regarding options trading. The company had been accused of encouraging inexperienced investors to engage in risky trading strategies without adequately disclosing the potential downsides. Regulatory probing led to Robinhood being fined $70 million. This put pressure on the company to adopt a more stringent supervisory process.
Robinhood’s case can be likened to the lackluster risk disclosure on many decentralized exchanges we see today. The learning curve for users onboarding and within Web3 remains steep, and the oversight of how on-chain code is implemented is minimal. Combine this with a rapidly evolving landscape and it becomes clear that adequate access to information will be the cornerstone of future innovation.
This suggests that government consultations such as the one recently undertaken by the U.K. government are important in defining the responsibilities of businesses to consumers and how these businesses should fundamentally operate.
There are many compelling Web2 examples where regulation played a crucial role in strengthening the industry’s foundations.
Regulation has encouraged greater ease of use by enforcing a higher level of base-customer protection.
In 2019, the European Union introduced new regulations that required all online payments to go through a two-factor authentication process called Strong Customer Authentication (SCA). This was introduced to prevent users from falling victim to scams and other instances of financial fraud.
Revolut responded to this regulation by developing an innovative solution that utilizes biometric authentication. The users of the service can now use their fingerprint or face recognition to authenticate their transactions, making the payment process faster and more secure. Thus, significantly improving their user experience.
This authentication requirement can be correlated to the use of hardware wallets in web3 that has an added layer of security before transactions are processed. Only individuals possessing the physical device are able to approve transactions. A simple analogy would be how one-time-passwords (OTP) are sent to mobile devices for Web2 payments. This stands in contrast to “hot” wallets that are connected to the internet and can be accessed virtually by anyone and anywhere around the world. Regulation that helps streamline this verification process for transactions could potentially help garner ease of use and further adoption. This would help strengthen the credibility of the Web3 ecosystem as platforms’ accessibility improves as a result.
Therefore, it is clear that regulation could and perhaps should fill this gap in Web3 to provide a more comprehensive level of protection for all consumers to prevent a total loss of funds in cases where bad actors attempt to take advantage of users’ inexperience. In doing so, businesses operating in Web3 can expand their operations with greater credibility.
It is evident that regulation in many instances has enabled innovation to progress and flourish. However, we must still approach the regulators’ superpowers with great caution.
Ideally, we would see a relationship in which regulation is utilized as a tool to serve to the benefit of Web3 rather than its detriment. So it remains to be seen whether lawmakers and regulators decide to curb innovation or supercharge it.
