A major obstacle to mass adoption of blockchains and smart contract applications has always been their undefined and contested legal and regulatory status. To qualify as genuinely innovative, these systems must hold some unique properties that distinguish them from what already exists, thereby justifying the need for their bespoke regulatory treatment. The cornerstone of this innovation is “sufficient decentralization” – a feature meant to guarantee reliability and resilience even in adversarial or otherwise challenging environments. Without this feature, the network or application in question is much easier to describe as a conventional software project and thus also easier to pigeonhole into an existing regulatory category. It is therefore not surprising that many blockchain projects, despite their financing, early development and launch being centrally coordinated by a small group of people, have established “progressive decentralization” as one of their core long-term objectives.
Presumably, the final stop on the path to progressive decentralization is regulatory compliance and thus the legitimization of the blockchain industry without sacrificing its founding principles. What compliance entails in practice has been a defining argument of the industry’s now almost 15-year history. The reason why this argument has not been particularly fruitful in terms of shared clarity for regulators and industry participants alike is that, on the one hand, existing regulatory frameworks are clearly anachronistic when it comes to blockchain technology and the types of organizations it enables; but, on the other hand, genuine innovation has also too often been intertwined with more traditional structures and practices that undeniably fall under well-established regulatory requirements. For projects that are serious about strong guarantees of transaction settlement and the minimization of central points of control and failure, navigating these two worlds simultaneously has often seemed an impossible task.
This state of regulatory limbo cannot last forever. The coevolutionary dynamic between innovation, institutional inertia, and amending existing or developing new regulations will eventually run its course. For the most part, the activities of traditional organizations that participate in the blockchain industry fall under existing laws in jurisdictions that these organizations are domiciled in. The lack of clarity is primarily concerned with more novel forms of organization such as public blockchains, smart contract applications, and their distributed token holder and governor communities as a whole, i.e., the category of decentralized autonomous organizations (DAOs), the associated cryptoassets, and the emerging onchain economy with its growing number of touchpoints with legacy systems. Depending on the jurisdiction, solving this regulatory puzzle may still take years but, eventually, it must and it will happen, paving the way for further institutionalization of blockchains as global administrative infrastructure.
In the meantime, blockchain-based projects and their proponents will continue exploring the frontiers of technological and governance innovation. Some may use their unique objectives and circumstances to justify ignoring or distancing themselves from the regulatory discussion; some will actively seek and contribute to the development of dedicated compliance frameworks; and some are likely to conclude that decentralization is not the right path after all, thus returning to more established organizational formats instead. But in all cases, for blockchains and smart contract applications to complement and compete with existing institutions at scale, there is no sustainable substitute to formally clarifying the legal and regulatory requirements of building, operating, and interacting with these systems.
The road to progressive decentralization runs parallel to – and will eventually intersect with – the road to progressive compliance. The challenge is that, while “decentralization” in crypto has a broadly global definition, regulation is and will likely remain a national, or at least a regional, matter. Thus, there is no universal playbook towards compliance beyond what should be obvious to anyone:
Seek legal advice that applies to your specific situation;
Make your best effort to comply with all applicable laws;
In areas that are contested or unclear, find ways to contribute towards a balanced regulatory outcome;
Once legal/regulatory clarity is achieved, make your best effort to comply with all applicable laws.
But the most important task at hand is to ensure that all of the above does not come at the cost of freedom to create and maintain open-source technologies, nor at the cost of what’s essential to the value proposition of blockchains: public verifiability of information, reduced reliance on the subjectivity of human administrators (automation), and tilting the power balance between institutions and individuals in favor of the latter (self-sovereignty). As long as that’s the case, the uniquely innovative core of the industry remains intact, regardless of the laws that end up regulating it.