Blockchain is increasingly popular in the financial industry, with banks all over the globe expected to make huge investments in the technology before the end of the decade.
Big names in the finance world are certainly starting to take notice, on both the regulatory and corporate side: Nasdaq representatives touted blockchain's transparency benefits when it started using the technology to trade shares in 2015, and earlier this year SEC Chair Mary Jo White said the agency is "actively exploring" blockchain compliance regulations to protect investors.
Digital commerce experts are not surprised that regulators are targeting blockchain, but wonder if lawmakers are ignoring the technology's security benefits.
"The blockchain is incredibly safe and secure and is a technological breakthrough in cybersecurity. The reason why is because of the distributed ledger, which is encrypted and consensus-based, as opposed to perimeter security models that we typically see," said Perianne Boring, founder and president of the Chamber of Digital Commerce, a trade association representing the digital asset and blockchain industry.
"We're looking at a new type of database security that we've never seen before, so it really challenges what people think of when they think of cybersecurity."
By definition, blockchain technology -- the distributed ledger that underpins Bitcoin and other cryptocurrencies -- stores a permanent, tamper-proof ledger of transaction data. These data security benefits are sometimes put on the back burner as blockchain tech comes under regulatory scrutiny.
Jon Holmquist, head of marketing at online payment processing provider GoCoin, said a big issue is that government regulators examining Bitcoin and digital currencies are looking at them as if they are another credit card or existing payment platform.
"It's an entirely new thing that opens up possibilities for much more secure consumer data," Holmquist said.
For consumers who distrust the government and corporations' suspect data management activities, the fact that blockchain puts security in the hands of users makes using it particularly enticing to them, he added.
"For me personally as a consumer, I feel like my information is most at risk when it is held by any company, or even governments," Holmquist said. "The nice thing about Bitcoin is it lets you have the option to essentially safeguard your own security, or safeguard your own data, because to use Bitcoin you really don't need to give much information out there."
Continued blockchain innovation
Bart Chilton, former Chairman of the U.S. Commodity Futures Trading Commission, predicted that there is a "100%" chance that there will be blockchain regulations, but added that the big question for the industry is "will they be part of that discussion, or will they have overly zealous regulations thrust upon them?"
Bart ChiltonSenior Policy Adviser, DLA Piper LLP
"I'm worried that this really promising technology embedded in blockchain will be stifled because people aren't working with regulators in an appropriate fashion," said Chilton, who is now a senior policy adviser at the law firm DLA Piper LLP.
By working with regulators, those in the industry can have a say in how it is regulated, rather than having blockchain compliance rules forced upon them. Chilton pointed to countries where Bitcoin is banned completely, such as Bolivia, Columbia, Ecuador, Bangladesh, Thailand, Vietnam and Iceland.
The main reason for the ban in these countries is the lack of proactive dialogue about appropriate regulations, he added.
"Without the discussion, what will happen is some regulators may just ban it -- that would really stifle innovation," Chilton said. "It's sort of looking at things one way or another without a balanced view that's the problem right now."
The most important factor that could hinder blockchain innovation is if regulators ignore the vast number of additional uses that the technology has for a variety of industries, Boring said. Virtual currency business models that are not engaged in money transmission should not be regulated as if they are, Boring said.
"We have to be very careful and define the business models correctly that regulators want to oversee," Boring said. "It's important that regulators make a distinction between currency applications like Bitcoin for payments or remittance, versus blockchain applications like smart contracts, record keeping, identity management, etc., that may not have anything to do with money transmission."
For example, if a company was building a smart contract platform to send and secure mortgage records over the blockchain, it would not make sense for that company to be regulated as a money transmitter, Boring said.
If the information that the company is sending via the blockchain is not clearly defined, however, it could trigger state-level money transmission compliance regulations -- and quickly.
"A software company could be looking at millions in reporting requirements that would pretty much make it impossible to operate," Boring said.
Examples of current blockchain compliance
Blockchain compliance regulations are not unprecedented, at least on the regional level. The New York Department of Financial Services (NYDFS) published the "BitLicense" regulations for virtual currency businesses in June 2015.
The New York regulations are designed to prevent money laundering and to improve cybersecurity for those using virtual currencies. In March, former NYDFS associate general counsel Dana Syracuse testified on digital currencies before the U.S. Energy and Commerce Committee, and noted that New York State's regulatory approach was a functional one.
"We started with the premise that digital currency had monetary value and didn't debate whether it was 'money' or 'currency' as defined under current law," said Syracuse, who is now Counsel at BuckleySandler LLP, during his testimony.
Instead, New York regulators focused on specific activities: the transmission, exchanges and selling, rather than classifying the value of the digital currencies.
"This meant not regulating Bitcoin, the underlying digital currency, or the blockchain technology, but rather the licensure of those that are acting as financial intermediaries or are providing financial services to the public," Syracuse said during his testimony.
North Carolina even scaled back regulations after the Chamber of Digital Commerce raised concerns that the state's Money Transmitters Act went beyond its original intent when it targeted blockchain technology. In December, the North Carolina Commissioner of Banks released guidance in the form of FAQs clarifying that virtual currency miners, multi-signature software and blockchain 2.0 entities such as smart contracts fell outside the scope of the Act.
"When we went through this legislation, our legal team analyzed it and determined that it could include all sorts of business models that really had nothing to do with currency," Boring said.
It doesn't necessarily have to be the government that does the regulating, either: By providing input into how regulations are developed, those that are actually in the virtual currency/blockchain industry can help shape policy that protects consumers and promotes innovation, Chilton said.
He pointed to FINRA for the securities industry and the National Futures Association for derivatives as examples of self-regulatory organizations that the blockchain industry could use as a model. Organizing a similar SRO specifically for the blockchain industry would help ensure due diligence and oversight is at least partly conducted by those most familiar with the technology, Chilton said.
"More and more of that needs to be done if this promising technology is not going to hit a roadblock and stifle innovation," Chilton said.