The physical world has borders and controls that the digital world is bubbling to destroy, says Chris Skinner. Where does this leave the regulator?

I was asked to explain what I meant by “haven’t central bankers realised that democratised trust is in the technologies and code?” when I blogged about the regulator’s views on bitcoin the other day. I wasn’t going to answer, but have been prompted to do so after attending the Blockchain Live conference in London.

The opening keynote came from Brendan Blumer (CEO of Block.one), Brock Pierce (partner of Block.one) and Daniel Larimer (CTO of Block.one). Block.one recently set a new record by raising approximately $185m in ether, Ethereum’s native token, through its initial coin offering (ICO). The crowd sale beat the previous record ICO of Bancor, which raised $153m in June 2017.

Block.one is also the developer of the EOS.IO software, which aims to put businesses on a blockchain by supporting “distributed applications that have the same look and feel as existing web-based applications” citing the many advantages of the decentralised technology in its “transparency, security, process integrity, speed and lower transactions costs”.

The guys talked for a while about DACs (decentralised autonomous corporations). Like DAO (decentralised autonomous organisations), DACs will allow any business to share the benefits equally between providers and users, rather than being purely driven for profitable returns to shareholders.

Daniel Larimer was one of the first people to capture the concept of DACs back in 2014, and at its simplest level of description a DAC is a company run by rules encoded as computer programs called smart contracts, while the DAC’s financial transaction record and program rules are maintained on a blockchain.

Smith + Crown’s Brian Lio explains what a DAC is rather well, if you want to know more, but it’s a hard topic to get your head around. In the same way as ICOs, distributed ledgers, blockchain and cryptocurrencies are tough to internalise, DACs are a challenge for anyone not a geek.

However, in my own simple view of the world, what’s happening is a hard fork in business and commerce. The old world works with governments, businesses and banks exchanging regulated contracts and currencies through centralised structures. Regulations are issued by government edicts and the community behaves through a physical policing operation. The new world works through open source software, where software controls what can and cannot be traded, enabling self-regulating markets to operate with trust through code. Regulations are written into the systems and the algorithms provide the digital policing operation.

All well and good. Or maybe not, as the physical world has borders and controls that the digital world is bubbling to destroy. The physical world is then trying to work out how to build their controls and policing into the digital world by, for example, banning ICOs and bitcoin trading in China. But the struggle here is that a government finds it hard to ban such trading, in the same way as they would find it hard to ban the internet.

A flaw in the argument

Equally, as the technologists put it, the internet and cryptocurrencies are not inherently bad or evil in themselves. It’s what you do with them that determines whether it’s for legitimate or illegal purposes. This is why I would come back to the fact that although DACs are reimagining business models by using tokens (a shareholding) that can be purchased using cryptocurrencies (a payment) through an ICO (exchange listing) via a trading system (an exchange), they will find that the regulators come after them through securities and financial regulatory models that apply equally to current financial products as they will to digital financial products.

The only flaw in this argument is that if regulators can only regulate what’s physical and local (national and domestic), they’re going to fail to regulate something that’s digital and global. That means a new regulatory structure is needed, and according to my DAC friends, the DAC regulatory structure are the software rules that apply to their operations.

This is also a flawed argument, because if a DAC is hacked (as the Ethereum DAO was) or an exchange is flaky (as Mt.Gox was), there’s nothing the investors can do to get their investment back.

There has to be a middle ground here, and it’s an evolutionary model of global platforms with software rules that allow for self-regulating structures which, should those structures break, will look for traditional laws to bail them out.

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– This article is reproduced with kind permission. Some minor changes have been made to reflect BankNXT style considerations. Read more here. Image by spainter_vfx, Shutterstock.com

About the author

Chris Skinner

Chris Skinner is an independent commentator on the financial markets through the Finanser, and chair of the European networking forum the Financial Services Club, which he founded in 2004. He is an author of numerous books covering everything from European regulations in banking through to the credit crisis, to the future of banking.

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