Chelsea Follett: Jack Solowey is a policy analyst at the Cato Institute Center for Monetary and Financial Alternatives, or CMFA, where he focuses on the regulation of cryptocurrencies, decentralized finance, and financial technology. His writing has appeared in RealClearMarkets, CoinDesk, the New York Daily News and other outlets, and he holds a JD from New York University School of Law and a BA in History from the University of Pennsylvania. And he joins us today to talk about cryptocurrency and its potential to contribute to human progress. How are you, Jack?
Jack Solowey: Doing well, Chelsea. How are you? Good to be with you today.
Chelsea Follett: Very well and excited to learn more about this topic. So let’s start with the big picture. We’ve all heard of cryptocurrency at this point, but what precisely is it and how does it work?
Jack Solowey: So it’s a really important question, Chelsea, and I think sometimes it could get glossed over in conversations about crypto that tend to look at the buzzy headlines regarding the prices of this novel type of asset or financial instrument. But at core, crypto describes an application of a class of technology known as blockchain technology, or sometimes Web3. And blockchain technology leverages cryptography and game theory to create highly tamper resistant public digital ledgers that can serve as a foundation for an open internet with sort of a ground truth that’s accessible by folks all over the world.
Jack Solowey: And cryptocurrency describes an application of this class of technology that leverages this advance of a distributed ledger that’s open and accessible to folks all over the world, and also is highly secure, highly resistant to tampering in its best form to basically replace sort of the traditional balance sheets at centralized financial institutions like banks and brokerages with this open distributed ledger. So in the same way that you might have an account with a bank that shows your balance, that’s replaced with a blockchain where your individualized account shows your balance in a particular cryptocurrency but different than a bank, is not managed by a centralized intermediary, but rather is run on computers all over the world that are incentivized to maintain this database and also check each other’s work to make sure it remains verifiable.
Chelsea Follett: And what are some of the potential benefits of cryptocurrency technology, particularly in poor countries such as Vietnam, you were mentioning in a pre podcast conversation we had?
Jack Solowey: Absolutely. So I hasten to note sort of at the outset of conversations like this, that because crypto, as we were saying, is a class of technology and it’s not a monolith, and that it’s relatively young, a lot of the benefits in this space, I tend to speak of as potential benefits. However, we do already in the real world see just sort of empirically use cases around the world where folks have taken to crypto to solve some of their real world problems. Now, I don’t… I focus on policy, so my role is to think about how regulators and policymakers can best approach this technological innovation. And to me it’s really about… The benefits are really what the market determines the benefits are and how folks employ it in their daily lives.
Jack Solowey: But we do see some really interesting data in terms of how it does get applied. So you mentioned Vietnam as one example of a country where crypto has taken on sort of an interesting role. So the blockchain analytics firm Chainalysis publishes an annual survey of the leading countries for crypto adoption. And Vietnam actually leads that list over a couple of years. And one of the interesting sort of corollaries is that Vietnam also sort of performs towards the bottom of the list on measures of access to traditional financial institutions. So it’s estimated that 69% of the Vietnamese population in Vietnam lack access to traditional banks. And so there correlation is not necessarily causation, but I think it’s a reasonable inference to look at the state of its existing traditional banking system and its high, relatively high rate of crypto adoption to see that this decentralized financial technology actually is serving a use and filling a need that is not otherwise being served by more traditional types of solutions.
Chelsea Follett: That’s really interesting. What do you think of this idea that cryptocurrency can be a hedge against inflation that some people bring up and of particular use to people in countries with unsound monetary policy?
Jack Solowey: So ultimately this is an empirical claim that will have to be evaluated and reevaluated over time. There was some thinking initially that cryptocurrency could be an inflation hedge because sort of the… While there’s different cryptocurrencies out there and they have different determinants of the size of the money supply, there was some thinking that either because that money supply increases at a fixed rate or has sort of an ultimate cap in the case of Bitcoin, where according to the protocol, there only will ever be 21 million Bitcoin minted. We’re still on our way there, there’s still more Bitcoin left to be minted, but there was some thinking that maybe these alternatives might provide an inflation hedge. And while it’s important to sort of know what time period you’re talking about, know what comparison you’re using, by my lights, the idea, for example, that Bitcoin specifically would be an inflation hedge vis-a-vis the US dollar just hasn’t borne out empirically, or at least hasn’t borne out yet.
Jack Solowey: With that said, there are places around the world where we’ve seen both national currency depreciation and relatively high crypto adoption, or cases where we’ve seen sort of spikes in crypto adoption around national currency depreciation events. And so countries that sort of have some… Exemplify some of this relationship include Turkey, Nigeria, Kenya, Argentina and Venezuela, although there’s sort of a lack of good data for some of their statistics on things like purchasing power parity per capita. So those are always taken with a grain of salt. And there’s different… I hasten to add that there’s different causes for sort of the monetary conditions in each of these countries, and there also could be different confounding factors for the rate of crypto adoption, but nonetheless, there’s sort of interesting places to look at where you have some national currency deficiencies, at least at some periods as well as interest in crypto.
Jack Solowey: Now, one thing that’s worth noting in this conversation is that there are different type… Not only are there different crypto tokens, there’s also different types of crypto tokens. What I mean by that, a lot of folks are familiar with tokens like Bitcoin and Ether, where the price is determined by supply and demand. However, there’s another class of crypto token known as stable coins, which are designed to be pegged to the value of another asset, which includes fiat currencies like the US dollar. And there’s different mechanisms that stable coins use to achieve that peg. There are what are known as algorithmic stable coins, which sort of use two digital assets from the same issuer and an engineered or a programmed exchange rate between the two to try to balance the forces of supply and demand to keep the price of the assets stable and in line with one US dollar.
Jack Solowey: Those have historically been somewhat volatile. Folks might be familiar with the deep pegging of Terra, that kicked off what some folks are referring to as crypto winter. But there are other types of stable coins, including both crypto backed stable coins as well as fiat asset-backed stable coins. So in a sense, stable coins have actually been growing in popularity in some of the same countries we were just mentioning that have had national currency depreciation issues, and it’s a way to access the US dollar. So that’s sort of an interesting application of the technology and one that’s not quite the same as the argument that crypto currencies with supply and demand determined prices will be inflation hedges, but it’s at least one application of the technology that does appear to be serving some folks in some countries.
Chelsea Follett: That makes sense. What about the potential benefits some people claim that cryptocurrency has regarding its potential or the potential of blockchain technology in general to combat censorship or resist authoritarianism?
Jack Solowey: So I think this is a really important question, and it gets to the idea we were talking about at the top of the conversation, that cryptocurrency is one application of an underlying suite of technology. And to understand the potential and the power of blockchain technology to resist authoritarian overreach in certain circumstances, I think it’s helpful to look at the tactics that are used by the totalitarian regime in George Orwell’s “Nineteen Eighty-Four,” I’m sure a lot of folks are familiar with that work. And in that story, control was a matter often of changing and deleting the historical record. The thinking being, if there was no evidence of a free society the idea of freedom or liberty could be extinguished in people’s minds. And then if the idea were to die, it would die in reality as well. That was sort of the goal of Big Brother’s Ministry of Truth.
Jack Solowey: And as we know, totalitarian regimes are not mere fiction. They exist tragically in the real world, outlawing things like freedom of speech, shutting down dissident publications. And so I’m really proud to say that the Cato Institute recently awarded the Milton Friedman Prize for Advancing Liberty to Jimmy Lai, who was the founder of the pro-democracy Apple Daily Newspaper in Hong Kong. Jimmy was an advocate… Is an advocate for civil and economic liberties, an outspoken critic of the Chinese Communist Party. And so there’s actually an interesting intersection with blockchain technology and Jimmy’s story.
Jack Solowey: When the central government in Beijing applied the draconian national security law to Hong Kong and raided the Apple Daily offices, arrested Jimmy and ultimately froze the papers bank account, there were folks, there were civic and cyber activists that were able to maintain a record of thousands of Apple Daily newspaper articles on the blockchain using a specific blockchain called Arweave. And one way to think about this, and one way that Arweave describes itself, is basically as a distributed hard drive, where instead of sort of centralized servers, the storage space is distributed around the world to thousands of computers on the network. And that is one example where blockchain technology sort of thwarted the Orwellian authoritarian ambition.
Chelsea Follett: That’s a great example. Do you have any other examples or stories that you can relate about the potential of blockchain technology to resist censorship or authoritarianism, because I think it’s a very important potential application?
Jack Solowey: Absolutely. So in general, it gets to some of the core capabilities of this class of technology, which at root is a matter of maintaining a secure and distributed record. And it uses a number of different sort of mechanisms to get there. And I think it’s worth discussing some of them because they sort of speak to the way in which the technology is decentralized. And I think there are some inherent sort of philosophical consistencies between the idea of decentralization and liberty, and on the other side of the coin between centralization and authoritarianism. What’s so interesting about blockchain technology is that it incentivizes folks to solve a coordinated action problem. There’s a specific problem in game theory known as the Byzantine Generals’ Problem, and it’s basically how do you solve this coordinated action problem where not every participant is necessarily going to be trustworthy?
Jack Solowey: And major crypto blockchains and crypto protocols empirically have been able to accomplish this. So the Bitcoin protocol uses a concept known as Proof of Work, which basically requires a certain investment of resources in the network to be able to participate in running the network and earning Bitcoin as a result of that participation. The Ethereum blockchain recently transitioned to another mechanism called Proof of Stake, which instead of computing resources involves sort of anteing up your crypto holdings potentially to gain more or where you sort of don’t contribute as an honest actor in the system, you could see them get taken away. And I know this is a bit of a digression into the technical weeds, but I think what the important takeaway here is that these technologies can solve, through voluntary cooperation, a form of action coordination problem without the need for state coercion.
Jack Solowey: And I think generally that is a way in which it sort of stands against sort of notions of state power and coercion that could can become overreaching and oppressive. And to sort of bring things down to earth, I will just offer a couple more examples of how this secure record keeping system can be used for humanitarian purposes. So just like Apple Daily’s articles were uploaded to a blockchain to be stored, we also see projects, one, through the group and the company Filecoin, where they are recording genocide survivor testimony. Similarly, this is a way to bear witness to human rights abuses throughout history and record people’s stories and make sure that they just can’t be erased by regimes for whom their stories are inconvenient.
Chelsea Follett: So we’ve talked about some of the potential benefits of crypto, but now let’s talk about some of the challenges or potential drawbacks of cryptocurrency. You talked about how it can help people to resist unjust censorship in some cases, but what about the critique that crypto can be used to break just laws as well and commit the kinds of crimes that we all agree are bad like hiring an assassin to murder someone? How big of a threat is that with crypto and is crypto unfairly singled out in your view with regards to its potential to fund crime?
Jack Solowey: Absolutely. So like all technologies, like all financial instruments, crypto can be abused by bad actors. It is a real… It is a problem, but just as it is for other technologies and other financial instruments. I think it’s important to be clear-eyed about that problem, that means neither minimizing it nor exaggerating it. So yes, there are crimes and not just sort of technical violations, but things like funding terrorist activity, committing trafficking around the world, be it of humans, be it of drugs. Folks might take issue with the idea of drug prohibition, but there’s also other forms of trafficking that could be enabled by the use of this financial technology and similarly sanctions evasion. So that does happen. I think it’s however important to keep in perspective sort of what the rate of it is in the crypto ecosystem and how that compares to the baseline of more traditional financial instruments. So it’s worth noting that even high estimates of crypto related illicit finance activity would make it in order of magnitude smaller than the UN’s estimate of, for example, total global money laundering each year.
Jack Solowey: And there are law enforcement agencies in the US that actually acknowledged that, the relatively small role of crypto in crime when compared to traditional financial technologies and tools. So the Treasury Department in their national money laundering risk assessment last year said that crypto use in money laundering, although growing, is far below that of fiat currency or more traditional methods. Secretary Janet Yellen testified before Congress that while they’re closely monitoring the risk of sanctions evasion through crypto, they hadn’t seen significant sanctions evasion through crypto so far.
Jack Solowey: And also Treasury’s National Terrorist Finance and Risk Assessment found that while it’s true terrorists have employed crypto, that use, in their view, appears to be limited compared to other financial products and services. And I think it’s worth noting here that folks… Bad actors might employ crypto for what they perceive as some of the privacy preserving potential, some of the ability to transact without financial institutions that require things like Know Your Customer rules. And while that’s definitely in the background, we shouldn’t inflate the risk, because as I said, proportionally the traditional financial instruments that tend to transact through either regulated institutions or are just conducted with things like cash show higher rates of illicit finance than crypto.
Chelsea Follett: So this conversation relates strongly to financial privacy. Can you speak to the relationship between crypto and financial privacy?
Jack Solowey: Absolutely. And this is a really interesting one. So I think there is something of a misunderstanding at times of the sort of privacy-preserving properties of certain crypto blockchains. So to take Bitcoin as an example, it is pseudonymous, meaning individuals’ accounts do not divulge their personal information up front. However, it’s not anonymous, so there is a linkage between, at least on the Bitcoin blockchain, between one’s account holdings and their financial transaction history on the Bitcoin blockchain. So there can be uses by crypto and blockchain analytics firms of those open immutable public blockchains for crime fighting purposes, for financial surveillance purposes, but there also are other technologies in the crypto ecosystem that can take privacy a step further beyond sort of initial pseudonymity. Those include privacy enhancing and enabling technologies known as mixers and tumblers.
Jack Solowey: One way I sort of think about a mixer is imagine a bunch of folks in trench coats, each holding sort of briefcase full of cash, and they all walk in to say Grand Central Station through revolving doors, and they hand off their briefcases to one another, and then they all exit and it’s unclear where the funds originated and where the funds went to. Now, the technologies don’t always work as flawlessly, depending on sort of the amount of liquidity that is being exchanged through the tumbler and the amount that one is trying to, for lack of a better word, sort of obfuscate through the tumbler or the mixer, but sort of a basic idea. There’s also other types of crypto tokens and blockchains that try to build in privacy from the ground up, so things like Zcash employ tools like sort of a leading edge cryptography idea, known as Zero Knowledge Proofs, to try to enhance privacy and not just rely on pseudonymity which can actually, through forensics and analytics, sometimes lead back to someone.
Chelsea Follett: Another common critique is that cryptocurrency technology is bad for the environment. And I know this is somewhat outside of your policy area, so we won’t treat this in depth, but just briefly, what do you make of that critique, and do you think this might be another case of cryptocurrency being somewhat unfairly singled out compared to other technologies?
Jack Solowey: So it’s an important question because this is one of the critiques that’s often leveled at crypto. But I think what’s important to understand about this critique is it often assumes off the bat that crypto is somehow not worth its footprint, and I think that can be emblematic of bias. And sometimes the arguments can get circular, so it’s sort of like, “Well, why is crypto sort of not a desirable technology for whatever reason?” “Well, there’s the environmental impact.” “Well, okay, so what about the environmental impact?” “Well, crypto is sort of not a worthwhile technology, so it’s footprint isn’t worth it.”
Jack Solowey: And to be fair, that’s not the argument that everyone makes, but it’s worth just sort of keeping it in mind the next time you hear things like it. It’s also worth distinguishing here between sort of the two mechanisms underlying major blockchains that I was speaking about a few minutes ago, you have Proof of Work, which helps secure the Bitcoin network, and because it’s compute-intensive, it’s also electricity intensive. So that’s where a lot of the critique, that it has sort of a disproportionate or outsized environmental impact, comes in. However, as we were also talking about a moment ago, there’s also a different mechanism, an alternative to what’s known as Proof of Work, called Proof of Stake, and that’s been implemented by the Ethereum blockchain, the second biggest network by market cap in the crypto ecosystem.
Jack Solowey: And Proof of Stake, when compared to Ethereum’s original Proof of Work mechanism, estimates have it that it reduces energy consumption and carbon footprint by over 99%. So some of the critique needs to adapt to the changing nature of the technology, but I also think it’s important to keep in mind sort of the way in which the critique begins with the assumption that the technology is not worthwhile. And from my perspective, that’s not really the role of policy makers. I think the role of policy makers is to address downside risks, but it’s not really to assess the benefits, that’s something I think should be left to consumers in the market. I will also note that you mentioned what I think is the important idea of sort of crypto being singled out or unfairly characterized on this environmental head. And I think regardless of one’s preferred environmental policy, it probably should apply uniformly. So the idea that sort of specific industries should come in for special treatment just doesn’t totally make sense to me as even just a baseline environmental policy matter. If there’s uniform standards, they should apply universally and should not be singling out one specific class of technology.
Chelsea Follett: I think that that is something that hopefully everyone can agree on. Another issue that some people have with cryptocurrency, to bring this back to a sort of international focus, is that El Salvador’s controversial leader, Nayib Bukele, he is often called a dictator or a strong man, really likes Bitcoin. What do you make of the idea of a country using Bitcoin as legal tender or any cryptocurrency as legal tender?
Jack Solowey: Yeah. No, it’s a great question. And I think I’ll actually address the second question first, ’cause I think it can give us a lens into understanding the first one about the experience in El Salvador specifically. So my colleague, Nick Anthony, at Cato CMFA, makes the important point that legal tender status and what it means, at least in the United States, is commonly misunderstood. And other folks in the crypto policy space like Jerry Brito at Coin Center and Jake Chervinsky at the Blockchain Association, also note that it’s a common misconception that because something is legal tender in the US, that means that every merchant is required to accept it. That’s actually not true legally if you ask both the Federal Reserve and the Treasury Department, who plainly state on their websites that there’s no federal statute mandating that a private business or an individual or an organization must accept currency or coins as payment for goods and services.
Jack Solowey: I think folks sometimes bring in the idea that legal tender, at least in the US, including Federal Reserve notes, must be accepted as a medium for tax payment and discharging debts and they conflate that with the idea that they must be accepted for payment for goods and services. And well, I think there’s sort of an interesting interpretation argument there, from the feds perspective, from treasuries perspective, they don’t interpret things that way. And so because legal tender status doesn’t mean that something automatically must be accepted by merchants, the idea of making any cryptocurrency a legal tender in the US doesn’t actually accomplish much, even if one’s goal for whatever reason is to see maximum crypto adoption, because it wouldn’t have the desired effect legally. And also I think this brings up an important liberty question, because I think it’s inconsistent with at least the ethos of the crypto ecosystem to want to mandate that any merchant must accept payment in crypto. I think it should be up to the merchants whether they find this type of instrument to be something that they want to accept as a means of payment, and I think the market should decide whether this is a useful medium of exchange.
Jack Solowey: And so that sort of takes us to the El Salvador question. And there, what’s interesting is that there’s now two forms of legal tender in El Salvador, there’s both the US dollar and now as you alluded to, Bitcoin. And, well, what’s interesting is that actually of the two, Bitcoin is the only one that’s known as forced legal tender. So there it actually is the case that merchants are legally required to accept payment in Bitcoin. And as we were just discussing, that raises real liberty problems, because forcing a merchant to accept any type of means of payment just isn’t consistent with a political philosophy that doesn’t wanna see coercion, doesn’t wanna see the state telling folks how they’re supposed to engage in transactions.
Jack Solowey: And I think it’s also worth noting that using tools of state power to force the adoption of technology doesn’t even necessarily work in the long run. In El Salvador, they basically gave folks a sign-up bonus to download the state approved Bitcoin wallet application. And folks initially… So it came with a $30 sign-up bonus, which was a significant chunk of change based on per capita annual income in El Salvador. So folks did download the app to get the $30 bonus, but after the bonus was spent, according to a study by the University of Chicago, and granted what, it is a year old, but it’s one of the better data analysis available at the moment at least, after folks spent their sign-up bonus, only 20% of folks continued to actually use the app. And similarly, not withstanding, the law at the time of the study, it was found that merchants, only 20% of large-sized merchants were even accepting Bitcoin, not withstanding with the law said. So there’s limits to how far state power can go in trying to force technology on people.
Chelsea Follett: So cryptocurrency adoption is not the kind of change that you believe can be mandated in the top-down way effectively?
Jack Solowey: Exactly. And nor should it. Folks, what’s exciting about crypto is it’s a decentralized technology, it can empower users all over the world to sort of take control of their financial lives without relying on traditional centralized intermediaries. And it would be, to me, a contradiction in terms to then use a centralized power to then force that on people.
Chelsea Follett: So now that we’ve discussed both some of the potential benefits of cryptocurrency and some of the potential objections to the technology, let’s get into what you mostly do, which is policy. How should policymakers respond to the rise of cryptocurrency to let people realize the potential gains from the technology?
Jack Solowey: Yeah. Well, I think you said it well. Policy makers should allow folks to realize the potential gains from cryptocurrency. And to me, that’s a matter of being neutral and open to the benefits, not sort of taking a stance or an opinion in advance, that it’s the role of policy makers to either promote or discourage the use of this technology. Policy should be risk-based, so there are sort of traditional risks in financial regulation, things like information asymmetries, things like agency problems, and intermediary risks where, “Is the middle man going to effect a transaction as they’re expected to? Are they going to appropriate customer funds that they’re custodying?” So there are sort of traditional risks that policy makers should be concerned with. However, the idea that it’s sort of a question whether policy makers should be for it or against it, and then they should… And if the answer is the latter, that it’s their role to try to extirpate it from the US, I think is just… There’s faulty premises there, in even the questions being asked.
Jack Solowey: I will also note, and I think this might come as a surprise to some folks, that the arguable regulatory hostility that the US has demonstrated towards crypto is not universal around the world. Places like the EU, UK, Japan, UAE, have either developed or are in the process of developing regulatory legal approaches to cryptocurrency that try to resolve regulatory uncertainty that’s been plaguing developers and users in the US. And that doesn’t mean that their answers are perfect, but it’s a far cry from what’s frankly been discussed, or at least you’ve seen the words being mouthed as recently as a few months ago in the US of potential bans on digital assets. And so it’s a very different approach to say, “Okay. This is a class of technology, it’s here. How do we approach this in a rational way from, “How do we consider policies and tools to potentially ban this or make it exceedingly difficult to access?””
Chelsea Follett: If cryptocurrency is over-regulated, what could be the possible impact of that for the average person, an ordinary American? What’s the potential loss there?
Jack Solowey: So surveys indicate that about one-sixth to one-fifth of Americans have interacted with crypto in some capacity. So the impact on the average American today may be indirect though. I think the big threat is the potential opportunity cost in forgoing the potential benefits in the future if our policies fail to adapt and basically make the US an uncommonly inhospitable jurisdiction for crypto, both because of outright loss of access to the potential gains from this class of technology, as well as the lack of competitive pressure that these innovations can put on existing and traditional institutions to improve and enhance their own products and services.
Jack Solowey: So I think it’s a potential loss in the future. But to sort of bring things down to concrete terms, especially for the Americans that are using crypto today, it can be a useful tool for sending faster and cheaper payments that settle in real time, it could be a tool for sending remittances cross-border, globally. That’s a really valuable solution that fills a need that is otherwise not addressed, or not sufficiently addressed by existing tools.
Jack Solowey: There’s also… I think one interesting lens into this problem is looking at what some policy makers view as a problem, which is the use of VPNs or virtual private networks to overcome some of the geo-fencing safeguards that certain crypto projects and exchanges use around the world because they think there’s too much compliance risk in the US, and they try to keep US customers off of their exchanges. But the very fact that US consumers are looking to use technical workaround to access this technology means that they, for various purposes, desire it. And consumer protections are ostensibly passed in the name of consumers, so I think it should be up to them to decide whether they are allowed access to these technologies and these financial instruments.
Chelsea Follett: So you’re saying that government should be neutral toward these technologies, not go into regulating them with any assumptions about the worth of the technologies. But in practice, what has been the approach that regulators have been pursuing?
Jack Solowey: Absolutely. So in the US, I think there’s two big problems with how regulators have been approaching this space. One is regulatory ambiguity, so for example, a space that I and my colleague, Jennifer Schulp, focus on a lot is interaction between existing securities laws and regulations and the crypto ecosystem. And securities laws in the US, at the federal level, are almost 100 years old with the Securities Act of 1933 and the Exchange Act of 1934. So it’s not hard to sort of conceptualize how technologies that began as paper stock certificates and are now being replaced potentially with tokenization over decentralized global networks could pose challenges to existing frameworks.
Jack Solowey: And that’s not to say that the law has never adapted to new technology. And in fact, in the 1990s, we saw the emergence of new communications technologies and protocols that were being used in the security space, for example. And at the time, at least, SEC actually went about a fairly rational rule-making process to adapt laws to the new technology, introducing something known as Reg ATS or the regulation of what are known as alternative trading systems. And so laws and rules can keep up with technology if regulators are willing to make those changes. Unfortunately, in the US, we haven’t seen SEC been willing to sort of take the same rational approach to new technology here. We’ve seen a bit of what I honestly view as gas lighting at times, where the agency can ask projects to register, say their exchanges under existing laws and the project will say, “Okay, great. Let’s do it.”
Jack Solowey: And then SEC says, “Well, we’re not really sure how to register your project.” And then a little bit later, they face enforcement actions for not registering their exchanges. So that’s really not a tenable status quo, and it’s just not a rational approach to innovation and financial markets. So that’s regulatory uncertainty. Another component is regulation by enforcement and too much regulatory discretion. So we did touch on this with SEC, instead of making new rules, launching enforcement actions, but this is a real problem because it doesn’t allow market participants to know what their obligations are upfront. And sort of penalizing projects when the rules are not clear, is again, just not a rational policy response to innovation.
Chelsea Follett: So we’ve been keeping this pretty big picture, but to get more specific, as of the time of this recording, what are some of the current policy initiatives around regulating this technology? What are some of the concerns people are currently wrangling with? And what are some proposals that you’re working on recently that relate to this?
Jack Solowey: Absolutely. So there is work being done in Congress right now to address stable coins, which we were talking about earlier in our conversation, as well as this idea of crypto market structure. So the US has sort of a unique position in that we have two capital market regulators in the US, we have the Securities and Exchange Commission, SEC, and the Commodity Futures Trading Commission, the CFTC. And it’s sort of an accident of history why we have these two regulators but they present sort of interesting questions when it comes to the crypto ecosystem, because there is this perennial question of whether crypto tokens ought to be treated as commodities or as securities.
Jack Solowey: And so my colleague, Jennifer Schulp, and I think it’s important to resolve some of the regulatory uncertainty that we were just talking about. So we propose a clear legal test for whether crypto tokens should be considered securities or commodities, and we hone in on the idea of decentralization, that’s really the innovation at the heart of cryptocurrency that we’ve been talking about during our conversation. And what’s interesting about decentralization, for example, in the securities context, is that it actually addresses some of the traditional risks that securities regulation grew up to mitigate, what are known as managerial risks, basically are the issuers of an instrument going to have information that market participants don’t have and could they use that information to gain an edge over market participants. So our securities laws have grown up to address things like insider trading and information asymmetries through disclosures.
Jack Solowey: But when you have a fully decentralized crypto token project, the idea that you have a managerial body at the heart of the project with that information, it’s just not the case anymore, when a project really is decentralized and there is no managerial body, but rather a software protocol that operates through clients on nodes, operating on thousands of computers all over the world based on code and the self-execution of code instead of a managerial body and their discretion. So we look to this core innovation to try to answer the question of when a project is a crypto security or a crypto commodity.
Jack Solowey: So at a high level, crypto securities are those that are centralized, crypto commodities are those that are decentralized. Now, an interesting wrinkle here that has genuinely sort of confounded folks and posed a problem for traditional regulators is that crypto tokens can begin life as centralized projects, however, they can evolve over time to more decentralized projects. So we propose a test for when the threshold of decentralization is met. To sort of preview it, it’s the question of whether you have that managerial body who’s promising performance without which the token would not exist or its benefits would not materialize. If a project is on the way there, but it’s not there yet, we provide sort of… Our proposal would provide for some sort of simple common sense disclosures that could address the traditional information asymmetries that are sort of a residual in a de-centralizing project.
Chelsea Follett: Now, because this is the Human Progress Podcast, we usually try to end on a positive note. So say regulators listen to you, heed all of your policy advice and they really get this right, and they manage to not over-regulate crypto currency, and they allow people to realize all of the potential gains of this technology, in a nutshell, what kind of gains could people see?
Jack Solowey: Sure. So in addition to the potential benefits through just making the US a more hospitable place for this innovation, allowing access to faster, cheaper payment methods, I also think there’s the potential for a more decentralized internet and financial system more broadly. So there’s this idea of decentralized finance or DeFi. And there’s a lot of really interesting developments and applications in the space, things like loans that could be issued permissionlessly, so in the same way that you put a dollar in a vending machine to get a can of soda, and the vending machine is basically programmed to give you the product once you put in your dollar, you can have lending protocols that once you put in the designated crypto collateral, you could take out a loan in crypto without sort of some of the traditional gatekeeping by financial institutions. And that’s just one example of this broader ecosystem.
Jack Solowey: And it’s sort of not for pundits necessarily to opine on what that ecosystem ultimately will look like. I would like to see entrepreneurs, developers and consumers themselves deciding what that world looks like. And so at least in the DeFi space, regulators should not be imposing mandates that either are counter-productive because they’re requiring additional intermediation, that is actually being sort of overcome by DeFi, or simply subjecting them to rules that are impossible to comply with.
Chelsea Follett: Thank you so much, Jack. This has been fascinating.
Jack Solowey: Thank you, Chelsea.