Web 3.0 Requires New Regulatory Thinking

“[A] digital economy isn’t simply an industrial economy on the internet.” The Blockchain Innovation Hub at the Royal Melbourne Institute of Technology in Australia recognizes a truth that governments around the world have yet to realize. Web 3.0, the approaching next Internet phase, with unprecedented methods of commerce, is unique in history. The Industrial Revolution transition is analogous. Changes of this magnitude require governments to reevaluate their economic oversight role. Web 3.0 will challenge old models of what constitutes a firm, a security, and a commercial transaction. The Royal Melbourne Institute provides some worthwhile proposals to welcome this new cyber world.   

Technology is creating a range of possibilities beneficial to everyone if not stifled by regulators. In the future, shareholders could run companies directly through smart contracts coded into decentralized applications—no management required. Cars could pay each other to pass or change lanes. Houses could rent out spare bedrooms based on predefined criteria. Computers could sell extra file storage to the continuously, to the highest bidder. And people could buy, share, and exchange value in myriad forms without any impeding central authority.

Thus far, wary governments have reacted in two ways. Those of a more authoritarian bent seek to capture the new technology while eliminating private competition. For instance, China began researching digital money in 2014. It plans to force its exclusive use at the cost of privacy, freedom, and political dissent.

Western democracies seek to force Web 3.0 innovations into compliance with familiar legal structures with which they share little. The administrative state’s paternalistic for-your-own-good dictates contradict the bottom-up-individual-empowered future. Risk aversion defines this approach as Securities and Exchange Commission (SEC) member Hester Peirce conveyed in a recent speech: “Regulators … tend to be skeptical of change because its consequences are difficult to foresee and figuring out how it fits into existing regulatory frameworks is difficult.” Overly cautious officials create confusion and uncertainty while forcing firm capital into legal departments.

Nowhere has government ineptness been more prominent than at the SEC. Chair Gary Gensler began his term calling for an active policy agenda and vigorous crypto prosecutions. The Commission’s legal basis for these prosecutions is the Supreme Court’s interpretation of “investment contract” arising from a 1940s dispute over orange groves.  

Orange groves as analog to code that can serve as currency, gateway keys, representations of physical objects, and countless other functions makes no sense. Nonetheless, through dated legal interpretations, the government has forced or threatened to shut down platforms the were or could have benefited the masses. The Commission’s litigation against Ripple has exposed its abusive tactics. But unless Congress—or a court’s ruling that the SEC has exceeded its authority—limits what constitutes “investment contracts” or removes it from the definition of security completely, the Commission will likely continue its war on innovators.

Unfortunately, the SEC is hardly an outlier. Other agencies have also moved to limit Web 3.0’s potential. Commodity Futures Trading Commission member Dan M. Berkovitz criticized decentralized finance as “Hobbesian” and questioned its legality. The Treasury Department has urged crippling crypto wallet regulations. Their allies in Congress have urged them forward.

Cooler heads at the Royal Melbourne Institute of Technology have suggested a better way that embraces innovation and discards the staid bureaucratic mindset. U.S. policy makers should heed their proposals lest Oz surpass America as the future’s preferred home.

These proposals include:

• Creating a new classification for management-less crypto firms known as Decentralized Autonomous Organizations (DAOs). Limited Liability DAOs would exempt token holders from liability in the same manner as principals in limited liability companies.
• Treating stablecoins pegged to fiat currency as ordinary currency without any special compliance features.
• Creating safe Harbors for innovation to shield non-fraudulent activity provided they meet certain requirements.
• Avoiding state-level licensing schemes like New York’s Bit License.
• Simplifying tax reporting.  

As the Institute states:

Transitioning to a digital economy is not simply placing our existing industries on the internet. It is a much deeper process of enabling and facilitating new business models and organizational structures, such as automation and decentralization.

To those creating the future economy this seems manifest. But only direct limitation of bureaucratic discretion will force government actors to agree.