Regulation and decentralization: Defending the blockchain

[A version of this post appears on the O’Reilly Radar blog.]

Editor’s note: our O’Reilly Radar Summit: Bitcoin & the Blockchain will take place on January 17, 2015, at Fort Mason in San Francisco. Andreas Antonopoulos, Vitalik Buterin, Naval Ravikant, and Bill Janeway are but a few of the confirmed speakers for the event. Learn more about the event and reserve your ticket here.

We recently announced a Radar summit on present and future applications of cryptocurrencies and blockchain technologies. In a webcast presentation one of our program chairs, Kieren James-Lubin, observed that we’re very much in the early days of these technologies. He also noted that the technologies are complex enough that most users will rely on service providers (like wallets) to securely store, transfer, and receive cryptocurrencies.

As some of these service providers reach a certain scale, they will start coming under the scrutiny of regulators. Certain tenets are likely to remain: currencies require continuous liquidity and large financial institutions need access to the lender of last resort.

There are also cultural norms that take time to change. Take the example of notaries, whose services seem amenable to being replaced by blockchain technologies. Such a wholesale change would entail adjusting rules and norms across localities, which means going up against the lobbying efforts of established incumbents.

One way to sway regulators and skeptics is to point out that the decentralized nature of the (bitcoin) blockchain can unlock innovation in financial services and other industries. Mastering Bitcoin author Andreas Antonopoulos did a masterful job highlighting this in his recent testimony before the Canadian Senate:

“Traditional models for financial payment networks and banking rely on centralized control in order to provide security. The architecture of a traditional financial network is built around a central authority, such as a clearinghouse. As a result, security and authority have to be vested in that central actor. The resulting security model looks like a series of concentric circles with very limited access to the center and increasing access as we move farther away from the center. However, even the most outermost circle cannot afford open access.

“Centralized financial networks can never be fully open to innovation because their security depends on access control. Incumbents in such networks effectively utilize access control to stifle innovation in competition, presenting it as consumer protection. Centralized financial networks are fragile and require multiple layers of oversight and regulation to ensure that the central actors do not abuse their authority and power for their own profit. Unfortunately, the centralized architecture of traditional financial systems concentrate power, creating cozy relationships between industry insiders and regulators, and often lead to regulatory capture, lax oversight, corruption, and, in the end, financial crises.”

In most countries, financial services need to comply with rules pertaining to Know your customer (KYC) and anti-money laundering (AML), and over the longterm, new payment networks based on distributed consensus (like blockchains) won’t be exempt from such requirements. In fact, there are already a handful of countries that have, for the moment, severely restricted (or even banned) cryptocurrencies. As Antonopoulos emphasized in his testimony, the challenge for regulators is striking the right balance so these new technologies can continue to spur innovations in mainstream applications:

“Bitcoin’s unique architecture and payment mechanism has important implications for network access, innovation, privacy, individual empowerment, consumer protection, and regulation. If a bad actor has access to the bitcoin network, they have no power over the network itself and do not compromise trust in the network. This means that the bitcoin network can be open to any participant without vetting, without authentication or identification, and without prior authorization.

“Not only can the network be open to anyone, but it can also be open to any software application, again, without prior vetting or authorization. The ability to innovate without permission at the edge of the bitcoin network is the same fundamental force that has driven Internet innovation for 20 years at a frenetic pace, creating enormous value for consumers, economic growth opportunities, and jobs.

“I urge you to resist the temptation to apply centralized solutions to this decentralized network. Centralizing bitcoin will weaken its security, dull its innovative potential, remove its most disruptive yet also most promising features, and disempower its users while empowering incumbents.”

The regulatory status of cryptocurrencies and blockchains will be among the topics we’ll address at one-day event — O’Reilly Radar Summit: Bitcoin & the Blockchain. Antonopoulos will be speaking at the event as well, but in the meantime if you want to learn more about bitcoin, join Antonopoulos in an upcoming free O’Reilly webcast.

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