by Don Tapscott
“My belief is the next five to ten years will be one of the most dynamic and interesting times in history for our financial system,” Lawsky said.33 He resigned from NYDFS to keep working on important issues at the heart of this dynamic environment. “I would enjoy my career if I got to spend my time working in the middle of what I believe is going to be an enormously transformative, dynamic, interesting time . . . you have this world of technology, which is usually largely unregulated, colliding with probably the most regulated system in the world, the financial system. No one really knows what comes of that collision,” he said. “It’s all going to work out over the next five to ten years and I want to be in the middle of that collision.”34
THE SENATOR WHO WOULD CHANGE THE WORLD
The Canadian Senate surprised many when, in June 2015, its Committee on Banking, Trade, and Commerce released an unambiguously positive and thoughtful report, “Digital Currency: You Can’t Flip This Coin.”35 Incorporating feedback from multiple stakeholders in the blockchain ecosystem, the report detailed why governments should embrace blockchain technology.36
“This could be the next Internet,” said Doug Black, the Canadian senator from Calgary, Alberta, and a major contributor to the report. “This could be the next TV, the next telephone. We want to signal both within and outside Canada, we support innovation and entrepreneurship.”37 Like Ben Lawsky, Black is a veteran lawyer. He made his career in the country’s oil patch, working on behalf of oil and gas producers as a partner at one of the country’s most prestigious law firms. Senator Black differs from Mr. Lawsky, however, in his reluctance to rush new regulations out the door. “Government should get out of the way!” Black told us.38 As members of the Canadian Senate, Senator Black and his colleagues have no formal legislative role, but can move the needle on important issues by issuing guidance or making recommendations to the government. Still, with an average age of sixty-six, the Canadian Senate wouldn’t be the odds-on favorite to embrace this cutting-edge technology. But that’s exactly what they did.
Reflecting on the process, Black recalled thinking, “How do we create an environment that encourages innovation as opposed to stifles innovation? . . . That’s unusual for a government to take that point of view from the get-go.” According to Black, governments “tend to be concerned about maintaining control and minimizing risk.”39 While acknowledging the risk any new technology poses to consumers and business alike, Black explained, “There’s risk in anything; there’s risk in fiat currency. We can manage risk at some level, but let’s also create an environment where innovation can be fostered.”40 With this report, Black believes they’ve hit the mark.
The report makes a number of recommendations, but two stand out. First, the government should start using the blockchain in its interactions with Canadians. Black said, “The blockchain is a more confidential vehicle to protect data”; therefore, “government should be looking to start utilizing this technology, which would be a powerful message.”41 This is a powerful statement: if you want to be the hub for innovation and a pioneer in the sector, put your money where your mouth is, and start innovating yourself.
The second recommendation is perhaps even more surprising: the government should take a light touch on regulation. A number of respected figures in the legal profession who focus on blockchain technology have made this argument. Aaron Wright of Cardozo School of Law, Yeshiva University, advocates for “safe harbor” laws that allow innovators to keep innovating while minimizing government regulations until the technology matures.42 Josh Fairfield, of Washington and Lee University Law School, said, “We need regulations that act like technology—humble, experimental, and iterative.”43
CENTRAL BANKS IN A DECENTRALIZED ECONOMY
Finance may be the second-oldest profession, but central banking is a relatively modern phenomenon. The U.S. Federal Reserve (the Fed), the world’s most powerful central bank, celebrated its centennial in 2013.44 Central banks, in their relatively short history, have gone through multiple reincarnations, the last one a big shift from the gold standard to a floating-rate system of fiat currencies. Because digital currencies challenge the role of central banks in an economy, we might expect central bankers to oppose blockchain technology. However, over the years, these bankers have shown a willingness to innovate. The Fed pioneered electronic clearing of funds by championing the Automated Clearing House (ACH) system when all checks were settled and cleared manually. Like central banks elsewhere, the Fed has savored experimentation. It has embraced unorthodox and untested policies, most famously (or infamously) the quantitative easing program in the wake of the 2008 financial crisis, when it used newly minted money to buy financial assets such as government bonds at an unprecedented scale.
Not surprisingly, central bankers have been forward thinking in understanding blockchain technology’s importance to their respective economies. There are two reasons for this leadership. First, this technology represents a powerful new tool for improving financial services, potentially disrupting many financial institutions and enhancing the performance of central banks in the global economy.
Second, and this is the big one, blockchain raises existential questions for central banks. How do they perform their role effectively in a global market with one or many cryptocurrencies outside their control? After all, monetary policy is a key lever in a central banker’s toolbox to manage the economy, particularly in times of crisis. What happens when that currency is not issued by a government but exists globally as part of a distributed network?
Central bankers everywhere are exploring these questions. Carolyn Wilkins, deputy governor of the Bank of Canada and a central banking veteran, told us, “We are confident in our paradigm right now, but we understand many paradigms have a shelf life: they’re going to work well for a number of years and then things are going to start to go wrong. You can fix it at the margin first, but eventually you just need to switch to something else.” She believes the blockchain could be that something else. “It’s hard not to be fascinated by something so transformative. This technology is being used in ways that have implications for central banking that span all the functions that we have,” she said.45
Ben Bernanke, former chair of the Fed, said in 2013 that blockchain technology could “promote a faster, more secure, and more efficient payment system.”46 Today, both the Fed and the Bank of England (and likely other central bankers who have not been as vocal) have teams dedicated to this technology.
To understand why central banks are so interested, let’s first address what central banks do. Broadly speaking, these august institutions perform three roles. First, they manage monetary policy by setting interest rates and controlling the money supply and in exceptional circumstances by injecting capital directly into the system. Second, they attempt to maintain financial stability. This means they act as the banker for government and for the banks in the financial system; they are the lender of last resort. Finally, central banks often share the responsibility with other government entities of regulating and monitoring the financial system, particularly the activities of banks that deal with savings and loans to average consumers.47 Invariably, all of these roles are intertwined and codependent.
Let’s start with financial stability. “As a central bank, our role is as a liquidity provider of last resort. We do that in Canadian dollars. Therefore, Canadian dollars are important as a source of liquidity for the Canadian financial system,” Wilkins said. What if transactions are in another currency like bitcoin? “Our ability to provide lender of last resort services would be limited.”48 The solution? Central banks could simply begin holding reserves in bitcoin, as they do in other currencies, and assets such as gold. They could also require financial institutions to hold reserves at the central bank in these nonstate currencies. These holdings would enable a central bank to perform their monetary role in both fiat and cryptocurrencies. Sounds prudent, right?
When considering financial stability relative to monetary policy, Wilki
ns said, “The implications [for monetary policy] of electronic money depend on how it’s denominated.” She suggested in a recent speech that “e-money,” as she called it, could be denominated by a government in a national currency or as a cryptocurrency.49 A digital currency denominated in Canadian dollars would be easy to manage, she said. If anything, it would help a central bank to respond more quickly. Most likely, we will see a combination of the two: central banks will hold and manage alternative blockchain-based currencies as they do foreign reserves and will explore converting fiat currency to so-called e-money through a blockchain-based ledger. This new world will look a lot different.
What about central banks as regulators and watchdogs? They have considerable regulatory power in their respective countries, but they do not operate in silos. They coordinate and collaborate with other central banks and with global institutions like the Financial Stability Board, the Bank for International Settlements, the International Monetary Fund, the World Bank, and others. We need stronger global coordination to address blockchain issues. Today, central bankers are asking important questions. Carolyn Wilkins said, “It’s easy to say that regulation should be proportionate to the problem, but what is the problem? And what are the innovations that we want?”50 These are great questions that we could address more effectively in an inclusive environment.
Bretton Woods is a good model. How about a second meeting of the minds, not conducted in smoky rooms behind closed doors, but in an open forum where various stakeholders, including the private sector, the technology community, and governance institutions could participate? Wilkins said, “The Bank of Canada works with other central banks on understanding this technology and what it means. We’ve had conferences that invited a variety of central banks and academics and people from the private sector.”51
Indeed, the story of central banks reveals a bigger issue: governments often lack the know-how to respond in a fast-changing world. Central bankers certainly have views that matter profoundly to this discussion, but they should look to other stakeholders in the network and other central banks globally to share ideas, collaborate on substantive leadership issues, and move the agenda forward.
REGULATION VERSUS GOVERNANCE
To be sure, value and money are different from traditional information. We’re talking about savings, a pension, a person’s livelihood, her company, her stock portfolio, her economy, and that affects everyone. Don’t we need regulation, and fast? Can and should government show restraint in the face of the seismic shifts to come?
Important shifts are revealing the limits of government in an age of accelerating innovation. For example, the 2008 financial crisis showed how the speed and complexity of the global economic system renders traditional centralized rule making and enforcement increasingly ineffective. But stronger regulation isn’t the antidote. Governments cannot hope to oversee and regulate every corner of the financial market, technology, or the economy, because there are simply too many actors, innovations, and products. If anything, the experience illustrates that governments can at least force transparency to shed light on behavior and create change. Governments can demand that the actions of banks, for example, be transparent on the Web and let citizens and other parties contribute their own data and observations. Citizens can even help enforce regulations, too, perhaps by changing their buying behavior or, armed with information, by organizing public campaigns that name and shame offenders.
Of course, governments must be key stakeholders and leaders in governance. They must also acknowledge that their role in governing the blockchain will be fundamentally different from their historical role in monetary policy and financial regulation. For millennia, states have had a monopoly on money. What happens when “money” is not issued exclusively by a central authority but instead is (at least in part) created by a distributed global peer-to-peer network?
While generally positive, the U.S. response has seemed at times contradictory. “In the U.S. there is a realization from Congress to the executive branch to different agencies including law enforcement that this technology has serious, legitimate uses,” said Jerry Brito.52 Indeed, the Internet has shown us that, by temperament and institutional design, the United States not only tolerates but welcomes innovations that push the boundaries. It also fences off innovation through regulations—some of which may be misguided and are almost certainly premature.
The risks of regulating prematurely—before firmly grasping the implications—can have profound consequences. During Victorian era England, so-called self-driving locomotives (i.e., automobiles) were mandated by law to be accompanied by a man walking in front waving a red flag to alert bystanders and horses of the coming arrival of this strange contraption. Steve Beauregard, CEO of GoCoin, a leading company in the industry, described the pitfalls of regulating too soon: “When Web pages were first going up, regulators were trying to determine what regulatory regime they should belong under. One idea surfaced requiring people who built and hosted Web sites to get a citizen’s band radio license because you’re broadcasting. Can you imagine having to have a CB radio license so you could put a Web site up?”53 Thankfully, this never came to pass.
Let’s be clear: regulation differs from governance. Regulation is about laws designed to control behavior. Governance is about stewardship, collaboration, and incentives to act on common interests. But experience suggests governments should approach regulating technologies cautiously, acting as a collaborative peer to other sectors of society, rather than as the heavy hand of the law. They must participate as players in a bottom-up governance ecosystem rather than as enforcers of a top-down regime of control.
Brito of Coin Center argued there is a role for governments, but they should exercise caution. He advocates for a multistakeholder solution, which starts with education: “briefing folks in Congress, at the agencies, in the media, and answering any of their questions or putting them in touch with the people who can intelligently answer their questions.”54
A NEW FRAMEWORK FOR BLOCKCHAIN GOVERNANCE
Rather than simply regulating, governments can improve the behavior of industries by making them more transparent and boosting civic engagement—not as a substitute for better regulation but as a complement to the existing systems. We believe effective regulation and, by extension, effective governance come from a multistakeholder approach where transparency and public participation are valued more highly and weigh more heavily in decision making. For the first time in human history, nonstate, multistakeholder networks are forming to solve global problems.
In recent decades, two major developments have provided the basis for a new model. First, the advent of the Internet has created the means for stakeholders of all sizes, down to individuals, to communicate, contribute resources, and coordinate action. We no longer need government officials to convene for the rest of us to align our goals and efforts. Second, businesses, academia, NGOs, and other nonstate stakeholders have gained the ability to play an important role in global cooperative efforts. There were no businesses, NGOs, or nonstate stakeholders at the table at Bretton Woods. Today, these stakeholders routinely engage with governments to address issues in all facets of society—from the governance of a global resource like the Internet to addressing global problems like climate change and human trafficking.
The combination of these developments enables the new model. For a growing list of global challenges, self-organizing collaborations can now achieve global cooperation, governance, and problem solving—and make faster, stronger progress than traditional state-based institutions.
In considering the foundation for a blockchain governance network, we pose a number of critical questions and develop a framework for answering them:
How do we design such a governance network?
Do we create a new network from scratch or build around an existing institution that already has a constituency that deals with international financial issues?
What will be the mandate for this network and w
ill it have the power to implement and enforce policy?
In whose interests will a blockchain governance network act and to whom is it accountable?
And critically, will nation-states actually cede any authority to a global network?
Overall, the ecosystem that governs the Internet is rich with lessons. That it has become a global resource in so short a time is astounding, in no small part thanks to strong leadership and governance and despite the powerful forces against it.
So who governs the first-generation Internet and how? A vast ecosystem of companies, civil society organizations, software developers, academics, and governments, namely the U.S. government, in an open, distributed, and collaborative manner that we cannot measure by traditional command-and-control hierarchies and frameworks. No governments or group of governments control the Internet or its standards, though several U.S. government agencies once funded it.55
In the early days of the Internet, governments showed both restraint and foresight. They showed restraint by limiting regulation and control throughout the Internet’s evolution and they showed foresight by allowing the ecosystem to flourish before trying to impose rules and regulations. This multistakeholder network worked for the Internet, but we need to recognize that there will be a greater role for regulation of blockchain technologies. Whereas the Internet democratized information, the blockchain democratizes value and cuts to the core of traditional industries like banking. Clearly there will be a regulatory role to ensure that consumers and citizens are protected. Yet our research suggests that the Internet governance model is a good template.