7 suggestions from a16z policy director to the US government: How to seize the Web3 opportunity?

By Brian Quintenz, Head of Policy at a16z

Compiled by: Luffy, Foresight News

It can be challenging for a government to develop effective policies for emerging technologies, especially when the technology does not fit into traditional regulatory frameworks. This is the case with Web3, as decentralized systems are inherently unable to comply with traditional legal requirements. For example, current rules assume the existence of some kind of centralized intermediary, which is typically absent in Web3. These rules are intended to reduce risks such as conflicts of interest and information asymmetry that arise from the presence of trusted centralized entities such as management teams; however, applying such rules to decentralized systems may force the system to be re-centralized, hinder innovation, undermine the transformative potential of Web3, and harm user interests.

Decentralization has reshaped social media, identity management, creative industries, and finance. Despite being the developed country with the highest cryptocurrency adoption rate, the United States does not have an effective regulatory system for decentralized crypto assets.

While the U.S. has made some progress (such as FIT21 and Wyoming’s DUNA), we still need significant legislative progress to provide regulatory clarity, properly encourage decentralization, and protect consumers. Regardless of who wins the U.S. election, government departments and agencies can take some simple steps (without legislation) to help the U.S. seize the Web3 opportunity.

Here are seven of the most important. While this list is not comprehensive, it should help the U.S. government and other stakeholders understand how to move in the right direction.

1. All relevant departments should include promoting competition and innovation within their responsibilities

As Marc Andreessen and Ben Horowitz have argued, the key to America’s tech hegemony has always been the startup. “A startup is a courageous group of outcasts and misfits who come together with a dream, ambition, courage, and a special set of skills to create something new for the world, to build a product that improves people’s lives, and to start a company that might go on to create more new things in the future,” they observed. Edison, Jobs, and Musk represent just a few of the leaders of America’s startups. America’s leadership in startups is largely due to competitive innovation generated by our pioneering spirit, work ethic, rule of law, strong capital markets, education system, and public sector investment in research and development.

Although startups can redefine old industries and, in some cases, even create new ones, they face a variety of possible disadvantages from the outset. Compared with large companies with large user bases and financial resources, startups often have a difficult start. Some old companies may have another advantage: the ability to make the government fight against startup competitors or impose expensive rules, thus forming a "regulatory barrier to entry."

If startups are the lifeblood of innovation in the United States, then all agencies should include promoting competition and innovation in their responsibilities, ensuring these goals are their top priorities.

2. The SEC should engage in formal rulemaking and provide clear guidance on the classification of digital asset transactions

When the staff of the U.S. Securities and Exchange Commission (SEC) has trouble defining which crypto asset transactions are securities, imagine how difficult it is for the average user. Due to the lack of clarity, the United States does not have a functioning digital asset market. To address this problem, the SEC should engage in rulemaking to provide clear instructions to market participants on whether a transaction in a particular digital asset involves the sale of a security, an action that would have many implications. But since 2019, the SEC has resisted calls to issue guidance to the public, instead choosing to engage in counterproductive regulation through enforcement, which could harm businesses, confuse investors, and disrupt everyday users.

3. Eliminate intermediary requirements. Blockchain eliminates the need for a third party

One of the key innovations of blockchain is the ability to conduct transactions without the need for a third-party centralized intermediary. However, the current rules designed for traditional markets presuppose the existence of centralized intermediaries such as brokers, clearing houses, custodians, and market makers.

Regulation is appropriate when centralized firms are involved in these functions. But treating decentralized systems in the same way prevents them from playing similar roles and insulates them from the benefits these systems provide. This amounts to a form of “technological discrimination.” Disintermediating services can reduce risks (such as counterparty risk) and costs (such as transaction fees) while increasing efficiency and promoting competition. If blockchain technology eliminates the need for intermediaries, regulators should remove intermediary requirements where relevant.

Likewise, by updating existing rules, institutions can help blockchain revolutionize our financial system. Cross-border payments, settlement of digital securities and commodity trades, and derivatives markets could all become more efficient if existing rules were adapted to transactions on the blockchain.

4. Improve transparency in agency decision-making processes and strengthen communication with private sector stakeholders, civil society organizations, academia, and the public

Improving transparency in institutional decision-making processes is critical to developing sound crypto policy. It builds trust, ensures accountability, and allows for public participation. An open dialogue with stakeholders ultimately leads to more effective regulatory solutions: firms work with regulators to explore these solutions to ensure regulators fully understand dynamic market structures and firms’ goals, operations, and risks. When institutions openly share how they make decisions, it also prevents undue influence from special interests and helps ensure policy fairness.

It is critical that agencies encourage (or at least allow) businesses to hold educational meetings with regulators without fear of retaliation from enforcement actions. This will help achieve what I call “regulation through dialogue,” rather than regulation through enforcement.

Transparency enables stakeholders, including innovators and the public, to provide feedback, thereby promoting a smarter, more inclusive approach to crypto regulation.

5. Allow White House staff and federal agency employees to use cryptocurrency

A 2022 legal advisory notice issued by the U.S. Office of Government Ethics prohibits “employees who hold cryptocurrencies or stablecoins” from participating in the development of cryptocurrency-related policies and regulations that could affect the value of their assets. The notice applies to all White House staff and federal agency employees and stipulates that the de minimis thresholds applicable to securities do not apply to cryptocurrencies.

Maintaining ethical standards regarding conflicts of interest is certainly important for building trust in government actions. But preventing government employees responsible for setting cryptocurrency rules from using cryptocurrencies is like prohibiting transportation officials from riding trains or planes. Government employees responsible for regulating cryptocurrencies should be allowed to use cryptocurrencies.

6. Provide specialized training for government employees

In addition to benefiting from their interactions with cryptocurrencies, government employees will benefit from specialized blockchain knowledge training. This is essential for understanding decentralized innovation, making informed policy decisions, and effectively using law enforcement resources. As decentralized systems reshape areas such as finance and cybersecurity, officials need to understand key concepts such as blockchain analysis, smart contract design, and decentralized governance. This training can help officials understand how to use the transparency of blockchain to better achieve regulatory goals. It will also help governments develop fair regulations, support blockchain-driven innovation, and ensure that public sector initiatives are consistent with the principles of decentralization and the public interest.

Partnerships are a good option. By working with industry, research institutions, and universities, governments can provide their staff with cutting-edge research and expertise in blockchain technology. Where such initiatives already exist (such as the SEC’s Strategic Center for Innovation and Financial Technology), agencies should leverage collaborations with innovators, developers, and builders of new technologies.

7. Support private sector blockchain research and use zero-knowledge proofs to better protect sensitive and proprietary information

U.S. government agencies should also promote research into open-source, permissionless blockchain systems to ensure national security. Many of our adversaries, including Russia, are developing government-backed blockchain protocols that, if adopted globally, could give hostile governments access to personally identifiable information and sensitive financial and operational data. U.S. agencies should support blockchain research to help develop private-sector solutions that could help the United States address the risk of losing out in the crypto space to other countries that do not share Western values.

One area where governments could benefit from R&D is in privacy-preserving technologies such as zero-knowledge proofs (ZKPs). ZKPs represent a significant improvement in privacy technology compared to other privacy-enhancing technologies, ensuring users receive the greatest degree of privacy and control.

ZKPs can directly benefit U.S. government agencies by helping them enhance information security and privacy. Blockchain provides a decentralized, secure ledger that ensures data is protected across multiple nodes. Encrypting and decentralizing information reduces the risk of hacker attacks and service disruptions. ZKPs allow parties to verify the authenticity of information without revealing the actual data, allowing only necessary proof of identity or authorization to be shared without exposing sensitive details. For example, proving that someone is over a certain age threshold without revealing their date of birth.

The combination of blockchain and zero-knowledge proofs can enhance data integrity, improve trust in digital systems, and protect confidential information in various government operations. Agencies can also use decentralized systems to improve data transmission, communications, etc. Therefore, agencies should consider using blockchain and zero-knowledge proofs to protect sensitive information and improve efficiency.

Summarize

The U.S. needs to do more to establish an effective crypto regulatory regime, one that incentivizes decentralization while protecting consumers. In the meantime, we hope this list of agency actions helps U.S. agencies and other stakeholders understand how to take steps in the right direction without waiting for new legislation. Perhaps, while we wait for legislation, workers may be allowed to actually adopt cryptocurrencies.