THE PAST twelve months have proven to be a banner year for blockchain and cryptocurrencies. The technology became a household name and the subject of breathless news coverage. Capital formation through so-called initial coin offerings (ICOs) approached $16 billion, surpassing traditional venture capital. A rogue nation-state created its own cryptocurrency to avoid sanctions, and the price of Bitcoin increased by nearly 1,000 percent to become arguably the largest financial bubble in the history of human civilization.
This Cambrian explosion of activity is an indication that these inventions, though still in their early and frothy stages, hold far-reaching implications for the global financial system and the United States’ standing as a global economic and innovation powerhouse.
On the national security front, the actors that control these technologies will have substantial hard- and soft-power leverage at their disposal in a future where conflicts are waged in cyberspace and through the use of economic technology.
From an international monetary perspective, the emergence of cryptocurrency as a functioning measure of value globally will have broad implications for the Bretton Woods system, where the dollar’s status as primary reserve currency has afforded the United States no shortage of geopolitical leverage. Global financial institutions and organizations such as the International Monetary Fund (IMF), the G20, the Bank of International Settlements (BIS) and the Organization for Economic Cooperation and Development are closely tracking these trends and moving deliberately to understand the consequences.
Competitor nations are also keenly monitoring these developments, eyeing an enhanced role for themselves on the global stage and investing in their own proprietary versions of the technology. China, for instance, is investing billions of dollars into blockchain development and leads the world in blockchain patent filings. Russia has been quite candid in that it sees blockchain as a means of dethroning the United States from its financial and economic pedestal.
WHAT'S DEFINITE is that a new digital monetary era is on the horizon; what’s uncertain is what role America will play in this system.
While the United States successfully employed a magic formula of light-touch regulation and targeted government support to spur the growth of the Internet two decades ago, it has taken a less visionary approach this time around. Instead, misconceptions, misunderstandings and a lack of regulatory clarity and applicability are inadvertently stifling innovation and forcing homegrown entrepreneurs to go elsewhere to build and test their products. These mistakes could result in the United States effectively ceding leadership in this area to other nations.
To date, the United States’ official stance toward blockchain and cryptocurrencies has largely centered on money laundering concerns, even though documented Bitcoin usage by bad actors—while a threat—is actually quite rare. In January 2018, the Foundation for Defense of Democracies found that just 0.61 percent of all transactions on the Bitcoin blockchain from 2013 to 2016 originated from an illicit entity. These concerns also frequently overlook the fact that blockchains are not inherently anonymous and can be programmed with Anti-Money Laundering (AML) and Know Your Customer provisions baked in, something that many good actors are actively trying to do.
The application of Industrial Era–regulatory taxonomy to new blockchain-fueled capital formation methods has also been a recurring theme. This reached a fever pitch in June when a Securities and Exchange Commission official remarked that ether, the native cryptocurrency of the Ethereum blockchain, is not a security in its current state—but didn’t offer concrete guide rails to similar projects looking to follow suit.
Such comments have obfuscated the role that crypto-tokens will soon play in economic activity and the true potential these systems offer—particularly in conjunction with other emerging technologies like artificial intelligence, the Internet of Things and robotic process automation. They also take for granted the question of the United States’ status as a leader in innovation, and fail to consider the steps it must take to spearhead the next technological revolution in the same way it led the last one.
At the crux of the problem is a regulatory logjam that applies yesterday’s rules to tomorrow’s economy. Numerous federal agencies have asserted jurisdiction over cryptocurrencies and issued confusing and even contradictory regulatory guidance, bogging innovators down with compliance costs and legal risk. States individually have their own diverse rules and regulations governing securities and money service businesses, complicating matters even further.
Such labyrinthine and non-malleable structures are a liability in a rapidly evolving state of play. In a 2016 essay about the onsetting Fourth Industrial Revolution, Klaus Schwab, founder and executive chairman of the World Economic Forum, argued that the ability of governmental systems to be nimble and adapt in the face of new technologies that redistribute and decentralize power will ultimately determine their survival.
As it currently stands, the United States is playing from behind in this emerging Distributed Era—in which business models and governance structures will be global, decentralized and mediated by technologies such as blockchains. There will be far-reaching implications if it is unable to regain a leadership position, as both technological and financial hegemony are at play this time around. Jobs, talent, capital formation and economic opportunity could be lost in the short term; technological dominance in the medium term; and a hastened phasing out of the dollar’s status as the global reserve currency in the long term. This development that would have unpredictable effects on both the United States and global economies.
But such a scenario is far from set in stone. By providing targeted action that affords regulatory clarity and relief, research and development support and a venue for experimentation with these technologies and business models until they can be better understood, as recommended in a July 2018 report by the U.S. Treasury Department, the United States can lead the next technological revolution in the same manner that it led the previous one.
COMPARISONS OF the current blockchain boom to the Internet craze of the 1990s are frequently and appropriately made, as both periods have been characterized by rapid technological disruption and new forms of wealth creation. However, the reality is that the current pace of technological change far surpasses anything witnessed two decades ago. This heightened pace of change is attributable to the Internet’s maturity as a global communication platform—allowing for instantaneous collaboration, criticism and feedback loops. Further, enormous sums of money are being thrown directly at technologists who don’t have traditional boards, management structures or investors attaching strings to those funds.
In 2017, an estimated $6.5 billion was raised through ICOs, whereby a startup funds itself by issuing a native cryptocurrency for use in its platform rather than equity. This trend has showed no signs of slowing down in 2018, with $9 billion being raised via ICOs through June, according to Autonomous NEXT, an industry research group. This activity comes against a backdrop of a marked slowdown in companies undertaking traditional initial public offerings, with the number of public companies in the United States now just half of what it was twenty years ago.
The Internet comparison also fails to paint a full picture of how disruptive blockchain and cryptocurrencies will truly be. While the Dot-com Era was largely a technology and business model play, blockchain has broader implications for the high-tech, financial markets and supply chain–driven business models that are the primary sources of U.S. economic strength. Technological innovation joined at the hip with financial, economic and capital formation innovations will make the wealth created by Silicon Valley in the 1990s look miniscule. Thus, the threat posed by falling behind the blockchain curve is that of losing Internet leadership multiplied by the threat of losing leadership of the capital formation industry.
It’s a troubling exercise to imagine what the world might look like today had Internet giants Google, Amazon, Apple and Facebook developed elsewhere. It’s far more concerning to envision a future in which the protocols that undergird global finance and commerce are controlled by an unfriendly nation.
AFTER BITCOIN was introduced in 2009 and incubated for years in the underworld of cypherpunk activists and anti–central bank libertarians, many U.S. financial and tech industry incumbents began taking heightened interest in the underlying blockchain systems around 2015.
To counter negative perceptions of Bitcoin, these incumbents began marketing a sanitized “blockchain, not Bitcoin” pitch that touts the technology, sans the cryptocurrency component, as a new type of database called “distributed ledger technology.”
While blockchain does have unique records management functionalities through its ability to seamlessly transfer value and achieve consensus among disparate parties that may not trust one another, the technology’s true value proposition has been overlooked: the ability to create programmable digital money that is governed by rules codified at the protocol level. This has led to the creation of economic ‘games’ in which the parties that play the game correctly and most effectively receive a financial reward that is significant enough to make playing by the rules more economical than trying to cheat.
Take Bitcoin. A disparate network of global players spends billions of dollars on computing power annually and consumes as much electricity as the nation of Switzerland, all in a race to be the first player to verify the transactions processed over the Bitcoin network—a process known as ‘mining.’ The winner earns a reward denominated in a ‘currency’ that exists only in cyberspace, yet today has a market capitalization in excess of $100 billion despite having no intrinsic value and no centralized authority ensuring proper conduct.