a16z Policy Director: How the U.S. Government Should Seize the Web3 Opportunity

Author: Brian Quintenz, Policy Lead at a16z

Compiled by: Luffy, Foresight News

For a government, formulating effective policies for emerging technologies can be challenging, especially when the technology does not fit within traditional regulatory frameworks. This is the case with Web3, as decentralized systems inherently cannot comply with conventional legal requirements. For example, current rules assume the existence of some centralized intermediary, whereas Web3 often lacks such intermediaries. These rules are designed to mitigate risks such as conflicts of interest and information asymmetry that arise from the presence of trusted centralized entities like management teams; however, applying such rules to decentralized systems may force the systems to re-centralize, stifling innovation, undermining the transformative potential of Web3, and harming user interests.

Decentralization has reshaped fields such as social media, identity management, creative industries, and finance. Although the United States is the developed country with the highest cryptocurrency adoption rate, it lacks an effective regulatory framework for decentralized crypto assets.

While the U.S. has made some progress (such as FIT21 and Wyoming's DUNA), significant legislative advancements are still needed to provide regulatory clarity, appropriately encourage decentralization, and protect consumers. Regardless of who wins the U.S. elections, government departments and agencies can take some simple steps (without legislation) to help the U.S. seize the opportunities presented by Web3.

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

1. Relevant departments should incorporate the promotion of competition and innovation into their responsibilities

As Marc Andreessen and Ben Horowitz have stated, the key to America's tech dominance has always been startups. They observed: "Startups are a group of brave misfits and outcasts who come together with dreams, ambitions, courage, and a unique set of skills to create new things for the world, build products that improve people's lives, and start companies that may continue to create more new things in the future." Edison, Jobs, and Musk are just a small representation of the leaders of American startups. America's leading position in startups is largely due to our spirit of exploration, work ethic, rule of law, strong capital markets, educational system, and public sector investment in R&D that fosters competitive innovation.

Although startups can redefine old industries and, in some cases, even create new ones, they face various potential disadvantages from the outset. Compared to large companies with extensive user bases and financial resources, startups often struggle to get off the ground. Some established companies may also have another advantage: the ability to leverage government to compete against startups or to impose costly rules that create "regulatory barriers to entry."

If startups are the lifeblood of American innovation, then all agencies should incorporate the promotion of competition and innovation into their responsibilities, ensuring these goals become their top priority.

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

When even the staff of the U.S. Securities and Exchange Commission (SEC) struggle to define which crypto asset transactions qualify as securities, imagine how difficult it is for the average user. Due to a lack of clarity, the U.S. lacks a functioning digital asset market. To address this issue, the SEC should engage in rule-making to provide clear guidance to market participants on whether specific digital asset transactions involve the sale of securities; taking this action would have numerous implications. However, since 2019, the SEC has resisted calls to issue guidance to the public, opting instead for counterproductive regulation through enforcement, which can harm businesses, confuse investors, and disrupt everyday users.

3. Eliminate intermediary requirements; blockchain eliminates the need for third parties

A key innovation of blockchain is the ability to conduct transactions without third-party centralized intermediaries. However, current rules designed for traditional markets presuppose the existence of centralized intermediaries, such as brokers, clearinghouses, custodians, and market makers.

When centralized companies perform these functions, regulation is appropriate. But treating decentralized systems in the same way would hinder them from serving similar roles and isolate the benefits these systems provide. This amounts to a form of "technological discrimination." Eliminating intermediary services can reduce risks (such as counterparty risk) and costs (such as transaction fees), while also increasing efficiency and fostering competition. If blockchain technology eliminates the need for intermediaries, regulators should remove intermediary requirements in relevant cases.

Similarly, by updating existing rules, agencies can help blockchain fundamentally transform our financial system. If existing rules can adapt to transactions on the blockchain, then cross-border payments, digital securities and commodity trading settlements, and derivatives markets can all become more efficient.

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

Increasing transparency in institutional decision-making processes is crucial for developing sound crypto policies. It can build trust, ensure accountability, and allow for public participation. Open dialogue with stakeholders will ultimately lead to more effective regulatory solutions: businesses and regulators collaborating to explore these solutions to ensure regulators fully understand the dynamic market structures, as well as the goals, operations, and risks of businesses. When institutions openly share how decisions are made, it can also prevent undue influence from special interests and help ensure policies are fair.

Crucially, institutions should 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 more informed and inclusive approach to crypto regulation.

5. Allow White House staff and federal agency employees to adopt cryptocurrencies

A legal advisory notice issued by the U.S. Office of Government Ethics in 2022 prohibits "employees who hold cryptocurrencies or stablecoins" from participating in the formulation of cryptocurrency-related policies and regulations that may affect the value of their assets. This notice applies to all White House staff and federal agency employees and states that the minimum threshold applicable to securities does not apply to cryptocurrencies.

Maintaining ethical standards regarding conflicts of interest is certainly important for building trust in government actions. However, preventing government employees responsible for formulating cryptocurrency rules from using cryptocurrencies is akin to prohibiting Department of 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 interactions with cryptocurrencies, government employees would also benefit from specialized training in blockchain knowledge. This is crucial for understanding decentralized innovation, making informed policy decisions, and effectively utilizing enforcement resources. As decentralized systems reshape fields 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 learn how to leverage the transparency of blockchain to better achieve regulatory goals. It will also assist the government in formulating fair regulations that support blockchain-driven innovation and ensure public sector initiatives align with the principles of decentralization and public interest.

Partnerships are a good option. By collaborating with industry, research institutions, and universities, the government can provide employees with cutting-edge research and expertise in blockchain technology. If such initiatives already exist (such as the SEC's Strategic Hub 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 on open-source, permissionless blockchain systems to ensure national security. Many of our adversaries, including Russia, are developing government-supported blockchain protocols that, if adopted globally, could allow hostile governments to access personal identification information as well as sensitive financial and operational data. U.S. agencies should support blockchain research to help develop private sector solutions that can assist the U.S. in addressing the risks of losing in the crypto space to countries that do not share Western values.

One area where the government can benefit from R&D is privacy-enhancing technologies, such as zero-knowledge proofs (ZKP). Compared to other privacy-enhancing technologies, ZKP represents a significant advancement in privacy technology, ensuring users achieve maximum privacy and control.

ZKP 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. Encrypted and decentralized information can reduce the risks of hacking and service disruptions. ZKP allows parties to verify the authenticity of information without revealing actual data, enabling the sharing of only necessary identity or authorization proofs without exposing sensitive details. For example, proving that someone is over a certain age without disclosing their birth date.

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

Conclusion

The U.S. needs to do more to establish an effective crypto regulatory framework that both incentivizes decentralization and protects consumers. Meanwhile, we hope this action list for institutions can help U.S. agencies and other stakeholders understand how to take steps in the right direction without waiting for new legislation. Perhaps, while we await legislation, staff may be allowed to actually adopt cryptocurrencies.