America should build on the Swiss model to regulate cryptocurrency

With the explosion of cryptocurrencies such as bitcoin, technology today has once again leapt far ahead of existing regulatory systems, causing a negative reaction from those who live in regulatory bubbles. Regulatory responses have varied, from China’s banning of many cryptocurrency activities to Japan’s decision to embrace some coins as currency. Today, applications of cryptocurrency technologies go far beyond the digital currency that bitcoin has become. The website CoinMarketCap lists over 1,500 cryptocurrencies, and no two appear to be exactly alike.

Cryptocurrencies have the potential to completely disrupt traditional regulatory systems because their underlying technologies have proven to be tremendously malleable. While this has allowed an explosion of new types of businesses, it is also forces regulators and politicians to tread carefully for fear of stifling economic growth. Government oversight of cryptocurrencies is a complicated solution, and the United States is still developing its approach.

{mosads}Several actions on Capitol Hill are promising. The Congressional Blockchain Caucus is currently pressing for a hands-off regulatory approach to blockchain — a key underlying technology that has many uses and in the case of bitcoin is in effect a digital ledger which records chronologically and publicly all transactions — so that industry and government can collaborate and ensure U.S. global competitiveness.

Congress also funds a Commodity Futures Trading Commission lab designed to promote innovation and regulatory clarity in the information technology and cryptocurrency sector. Testifying in February before the Senate Banking Committee, Securities and Exchange Commission Chairman Jay Clayton and Commodities Future Trading Commission Chairman Christopher Giancarlo, described their work on regulations to address problems, such as fraud, while still allowing innovation.

While the tone and approach of these regulatory leaders and of many senators attending the hearing were seen as positive in Silicon Valley, if the United States is to remain a leader in technology, Congress and the relevant regulators need to adopt flexible systems that emphasize principles over set rigid rules.

The United States has remained on the cutting edge of information technology because of its ability to embrace the rough and tumble of free markets and the clarity of the rule of law with respect to commercial transactions. So how can Congress and regulatory agencies deal with diverse and rapidly changing cryptocurrency business models, some of which fit traditional regulatory categories like currency or securities in some instances, but often do not?

An interesting example is Switzerland which has taken an innovative approach. Its guidelines for initial coin offerings (ICOs) classifies cryptocurrencies into three types: payment tokens like bitcoin, utility tokens that provide access to a service, and asset tokens that represent participation in hard assets, companies, or profit or capital flows. The guidelines also allow that there can be hybrid coins that serve multiple purposes. The Swiss approach provides regulatory clarity with some flexibility, but if the United States adopted something similar, it would need three additional features that promote even greater innovation.

First, there should be an industry standards committee. Each cryptocurrency business is built on a software platform that requires great expertise to understand. A standards committee could ensure each platform does what it says it will do and no more. Issuers of new cryptocurrencies hire auditors to pass judgment on the software. Industry standards could lower costs and provide greater public confidence.

Second, a regulatory sandbox would provide a place for experiments that go beyond variations of the three categories identified by Switzerland. Regulators are still tempted to rely on traditional regulatory silos, such as “securities.” This was evident in Clayton’s testimony in which he noted that in his opinion every ICO has elements of a security offering while being called an ICO “which sounds pretty close to an IPO.”

A regulatory silo approach made sense in a brick and mortar world but not today. Cryptocurrencies present an opportunity to rethink the silo approach and allow commercial agreements to evolve with technology. Smart contracts, essentially financial agreements embedded in the software platforms, are being used to resolve “trust” issues, such as whether someone will make a promised payment. But while they are effective in some circumstances, the fact that they are embedded in computer code that is understandable only to a limited number of people may create new problems.

Third, Congress should require regulators to find ways to lower regulatory costs. One reason for the rapid growth of cryptocurrencies is that there has been a large untapped demand for financial and legal instruments that are less costly and more flexible than our traditional mechanisms for money transfers, providing capital for startups, exchanging goods and services, and developing and enforcing contracts.

The United States should use its traditional embrace of innovation to its advantage. Today, regulators and politicians alike need to accept the reality that we are in a time of constant change, for good.

Mark A. Jamison is a visiting scholar at the American Enterprise Institute and director of the University of Florida Public Utility Research Center.