In January, two government entities issued important position papers on blockchain technology within days of each other. Both supported the technology's potential for reducing costs, improving security and transparency, and enhancing financial services industry logistics. One was issued by the United Kingdom's powerful Government Office for Science, chaired by the country's chief scientific adviser, Mark Walport. The other was issued by Vermont, a state with a lesser claim to regulatory leadership and located far from any financial center.
This reflects a sharp divide between the regulatory environments in Europe and the United States. In the U.K., a discussion about blockchain is entering the mainstream of public policy circles. Here in the U.S., it is still on the fringes. This difference could give the former a notable advantage in attracting the best and brightest blockchain developers, helping European financial institutions get a competitive leg up in developing blockchain systems over U.S. rivals.
Yes, Vermont's report is to be applauded. While the report determined that blockchain technology was not appropriate for the state's own recordkeeping, the home of Ben & Jerry's, Bernie Sanders and powdery ski slopes still saw how embracing the technology could be transformative. Specifically, the report said: "Providing legal recognition of blockchain technology may create a 'first mover' advantage with the potential to bring economic activity surrounding the development of blockchain technology to Vermont, but this potential is difficult to quantify and challenging to capture due to the nature of the technology."
However, for market participants hoping that U.S. regulators might take as supportive and coherent a stance toward blockchain as, say, the U.K. has done, the fact that Vermont is among the first jurisdictions stateside to take a position is not particularly encouraging.
Vermont has no financial services industry. While its report calls for new legislation to cover instances where blockchain applications are not covered by the state's Uniform Electronic Transactions Act, such a reform would not likely have any measurable effect outside of Vermont's borders.
In general, European regulators have been more proactive when it comes to evaluating the potential benefits of and risks of blockchain in trading applications, such as through smart contracts. This might be the result of the regulatory structure. Overseas, the arrangement of regulators is simpler, with authorities clearly defined, whereas the U.S. structure favors overlapping authorities of many agencies that often breeds inaction. U.K. regulators can truly shape new regulations, whereas the jurisdiction of their U.S. counterparts is unclear.
For example, the recent U.K. report on blockchain explores the possibility of a new form of regulation that would focus on rules governing the technical code behind a blockchain system. Last April, the European Securities and Markets Authority also issued a paper outlining basic questions and asking for industry comment on virtual currency as well as distributed ledger technology. The ESMA is currently evaluating the comments.
Faster developments in the U.K. may not be occurring in a vacuum as officials demonstrate a competitive spirit. In October, Member of Parliament Harriett Baldwin, the economic secretary to the U.K. Treasury, said in a speech on big data, virtual currencies and blockchain, "We are already a major player in financial technology; our ambition is now to be the major player — the leading fintech center in the world."
The closest the U.S. has to a policymaker with a similarly bold vision is someone no longer in the government: former Securities and Exchange Commission Chairman Arthur Levitt, who now advises and advocates for some bitcoin companies.
The difference between the more unified, positive approach to blockchain development in Europe compared to the lack of a strong regulatory advocate in the U.S. could begin to have a notable impact if European regulators address certain critical unresolved issues ahead of the U.S. Those include the need for rules on enhanced transparency for blockchain platforms, establishing reporting standards, and so on.
European regulators have generally advocated a "light touch" approach on fintech policy. And in the U.K., the regulators have allocated 42 million pounds for research into how to foster the fintech industry. In the U.S., there are no comparable government champions.
Before regulators even write rules, they need to consider the extent to which blockchain systems require new rules in the first place. As discussed in the Government Office of Science paper, it is hard to regulate a decentralized ledger that does not have a physical owner. The paper says that it might be necessary to regulate a distributed ledger and its participants through the system's codes. But watchdogs who feel this way need to tread carefully if they want to avoid stifling innovation.
Also in flux is how regulators both in the U.S. and abroad will apply privacy and anti-terrorism laws to blockchain systems. While some jurisdictions — such as New York State — have acted to license bitcoin exchanges, nothing of the sort has been proposed for the blockchain itself.
Before any jurisdiction writes new policy, it may be useful for regulators to hold their fire until one or more blockchain systems specializing in trading attracts enough clients to be viable. Right now, financial watchdogs don't really have much to regulate. This explains why, rather than developing regulatory models, European governments are first investigating the development of the technology. The Bank of England has even offered special internships to students who are versed in cryptocurrency and blockchain technologies.
If the European regulatory environment proves friendlier to blockchain developers, it won't be the end of the world for U.S. financial institutions. Eventually, the technology will migrate. But in a world where financial institutions and economies are buffeted by volatility, wrestling with costly regulations and needing to make every basis point count, U.S. institutions could still lose an important competitive edge.
Daniel S. Alter is itBit's general counsel and chief compliance officer. He previously served as the general counsel to the New York State Department of Financial Services.