Bitcoin, Blockchains and Regulation

Blockchain-based technologies could revolutionize not only how companies operate but also how regulators and law enforcement officers perform their supervisory and investigative duties. Could the transparency, user-defined privacy and programmability of blockchains minimize market failures and reduce the need for regulation?

The First Blockchain

Through an ingenious combination of well-known technologies and economic incentives, Bitcoin brought about one of the most exciting and potentially transformative inventions in modern history —the ability to achieve consensus and guarantee truth without a central authority and with censorship-resistance. So revolutionary is this breakthrough that it has ignited a gold rush of investment and creativity similar to the pre-browser years of the Internet.

Blockchains were born with Bitcoin. And by Bitcoin I do not mean bitcoin (lowercase), the volatile and supposedly anonymous virtual currency that is not controlled by any third party, and allows individuals with Internet connectivity to send and receive value in any amount, globally, and almost for free. Lowercase bitcoins are an inextricable component of this new technology, and a uniquely significant one that transcends their monetary nature. They are digital containers that can be programmed to represent digitally “anything of value,” such as a security, a medical record or a work of art.

Bitcoin (uppercase) is an open source software that runs as a distributed network made up of thousands of smaller computers —nodes— that jointly certify the ownership and transfer of value without having to trust one another. In this sense, Bitcoin acts as as a semi-autonomous robot that utilizes advanced cryptography to enforce rules embedded in its core that guarantee everyone’s honest behavior. Part of that enforcement mechanism consists of recording transactions in a counterfeit-proof and immutable ledger that is also distributed to all participants in the network. This public ledger —Bitcoin’s database— is called the blockchain.

Bitcoin’s Brethren

Over the past few years, alternative software platforms with shared cryptographic ledgers have emerged to address Bitcoin’s real and perceived shortcomings, to meet the particular needs and interests of their creators, or to comply with current regulatory standards. The plural blockchains refers thus to a number of apparently similar but distinct databases and consensus protocols inspired by the original blockchain.

Today, blockchain-based platforms —blockchains for short— come in multiple flavors: they can be public or private, open source or proprietary. Some feature a digital container or token. Others don’t. Some —so-called permissioned— require the full identification of their users and network participants or transaction validators. Others —so-called permissionless—are open to anyone, anywhere in the world. Some allow the programming of self-executing contracts of any kind. Others have more limited programmability. In the near future, multiple blockchains of different flavors are bound to coexist, and technology will need to be built to make them compatible and interoperable.

Whatever their design and features, blockchains promise to fundamentally alter how assets, processes and operations are designed, distributed and controlled, with the ultimate expectation to achieve efficiency gains, cost savings, financial inclusion and better risk mitigation. This is the reason why large and small financial and non-financial institutions around the globe, including governments, are experimenting with blockchain-based applications that range from securities settlement to property deed registries and voting systems.

In the near future, multiple blockchains of different flavors are bound to coexist, and technology will need to be built to make them compatible and interoperable.

Regulatory Challenges & Opportunities

Indeed, as easy as visualizing the enormous positive impact that shared cryptographic ledger technologies could have on the global economy is to notice the big challenges facing and risks posed by them.

Are blockchains attractive to criminals? Are they vulnerable to money laundering or other criminal abuse? Do they pose a threat to national security? Are they safe for consumers and businesses to use? Are they reliable, resilient and sustainable? What are the risks of financial loss to consumers and investors? Are they simple to understand and use? Is it possible to evade taxes or break other laws with them? If ledgers are public or shared across multiple parties, can privacy and confidentiality be protected and preserved? These are some valid questions and concerns that society, by means of its government institutions, should naturally ask and is actually asking itself.

By the same token, questions about regulatory oversight and compliance also arise: Are current regulations adequate and appropriate? Are new or different regulations necessary? Can the same regulations be applied to both closed and centralized versus open and decentralized systems? Should they? Can financial intermediaries utilizing these emerging open technologies use the same compliance tools and techniques as traditional financial institutions? Can better reporting and monitoring systems be built?

In this digital day and age, modern technology —especially shared cryptographic ledgers— have the interesting dual property of being potentially transformative and disruptive while at the same time offering opportunities for improved oversight and control. The purpose of government regulation is to prevent or compensate for market failures. Could the transparency, user-defined privacy and programmability of blockchains minimize market failures and reduce the need for regulation?

Could the transparency, user-defined privacy and programmability of blockchains minimize market failures and reduce the need for regulation?

Moving Forward

It is evident that blockchains will challenge more than the status quo —they will make us revise and redefine many of today’s assumptions about identity, security, privacy and even regulatory oversight. And paradigms are bound to change.

In the coming months, I will be exploring in further detail the issues, concepts and ideas laid out in this first post as EVP of Coinalytics. In addition, Coinalytics will be holding a series of events related to these important topics, the first of which is this panel discussion in San Francisco on March 15.

I am honored and excited to be joining the Coinalytics team at such an exciting time in the evolution of advanced analytics and blockchain technologies. Coinalytics combines deep expertise of Bitcoin and other distributed ledger technologies with the state-of-the-art in machine learning and artificial intelligence. We are excited to be building technology solutions that are poised to revolutionize business and financial intelligence in the blockchain age.