Regulating Crypto Will Drive Innovation



Too much regulation can kill innovation, but so can too little regulation.
That was the core message NYU professor and economist Hanna Halaburda had for PYMNTS’ Karen Webster when they discussed the cryptocurrency industry’s fight to influence the lawmakers and regulators that are now drafting the rules that will govern the future of digital assets in America — and, given the U.S. economy’s global influence, far beyond.
Whether they’re overseeing crypto markets or the Chicago Mercantile Exchange, regulators have to strike a fine balance between ensuring markets run efficiently and protecting consumers, said Halaburda, an associate professor of technology, operations and statistics at the Stern School of Business. Ultimately, the same economic principles always apply.
“What we see is that we have new opportunities and new challenges, and both opportunities and challenges come from incentives, and dealing with incentives is what economists do,” said Halaburda, who has written extensively on blockchain and cryptocurrencies, with particular emphasis on how centralized and decentralized networks work.
From a regulatory perspective, the problem is that the blockchain technology all cryptocurrencies are built on was created for bitcoin — which has creating a censorship-resistant currency and payment system as its key goal.
As a result, its incentives point in the opposite direction of regulation. This is as much of a problem for the crypto industry as censorship was for bitcoin, given that it’s a currency designed to live outside of national borders.
“There’s a feedback effect, because if the space is not regulated, that actually holds down some of the adoption and some of the innovations,” Halaburda said.
As expanding use cases convince more people new to cryptocurrency to consider jumping into a new field of investment and source of services — particularly one often seen through the lens of high-profile frauds, multimillion-dollar hacks and just plain old failures — the need for regulation is becoming clearer.
“The providers of those services actually would find it attractive to say, ‘We comply with regulations, we have regulators’ stamp of approval,’ which is kind of a sign of quality,” Halaburda told Webster. “It lets them say, ‘We are well designed and we do not have malicious intent and our code is not going to benefit us.’”
So, she added, “regulation may stifle innovation, but may also encourage innovation.”
How to Regulate
The crypto and blockchain industry is pretty broad, with some tokens acting as alternative currencies and others as utility tokens that power decentralized applications (DApps), ranging from supply chain management to decentralized finance (DeFi). As such, a regulatory framework for understanding it needs to be similarly broad.
That said, it requires a light touch, Halaburda emphasized. Pointing to utility tokens, she gave the example of projects providing decentralized data storage that can store peer-to-peer content — a key piece of puzzle for creating a decentralized web, better known as Web3.
“That may create new business models and new systems,” Halaburda said. “We need to think about how those tools are being used — creating new economic possibilities, new economic activities.”
That’s true, she added, whether a token has actual value or whether it’s simply a trading mechanism. One part of that is enforcing existing rules, Halaburda said.
“We already have money laundering rules,” she noted. “We already have anti-terrorist financing rules. We already have rules against setting up Ponzi schemes. So, it’s applying the same rules.”
She acknowledged that “the permissionless nature of blockchain makes it much more difficult and much more costly to find the perpetrators,” adding that, “once we find them, and actually it’s easier to prosecute them because the proof is there on the blockchain.”
Another part is establishing rules that apply specifically to crypto, Halaburda said.
“For example, we see governance attacks conducted with flash loans that are just not possible in traditional financial markets,” she said.
The way this works is that decentralized applications and protocols are governed by tokens that give holders voting rights on how the project is managed.
See also: PYMNTS DeFi Series: Unpacking DeFi and DAO
Using those loans, attackers “can borrow a number of governance tokens, vote in their own favor and completely change the trajectory of the protocol,” Halaburda said. “And we don’t have rules against that.”
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