Rules Make the Game

May 24, 2023

Creating Clear Frameworks Is A Precursor To Winning the Crypto Regulatory Arbitrage Game

We’re going to start with a game. I’m going to group ten countries into two sets:

In which set of countries would you prefer to set up your next corporate headquarters or subsidiary? 

If you’re working in the digital assets space, you might be surprised to know that the United States falls within Set B, countries that take a hostile approach to crypto. Set A, as you probably guessed, is a short list of countries with blockchain-friendly laws.

Even people who pay casual attention to the news cycle, let alone the echo chamber that is crypto journalism, understand that the United States is struggling to offer any sense of clarity as to how blockchain-based businesses should operate within that country. The U.S.'s two regulatory bodies who could naturally claim jurisdiction over digital assets, the Commodities and Futures Exchange Commission and the Securities and Exchange Commission (SEC), can’t agree on how to classify these assets, let alone how to apply the patchwork of laws that has come into place since these agencies were created nearly 50 and 100 years ago, respectively. The White House sends mixed signals but is generally bearish on digital assets, and Congress, despite what may be characterized as recent progress, has completely failed to keep up with countries like Hong Kong and Dubai that have provided regulatory frameworks for digital assets. 

In all this uncertainty exists an opportunity for countries to become the go-to jurisdiction for a founder wishing to start a digital assets business, or the place to relocate a blockchain project when it gets regulated out of its home country – that is, countries have the opportunity to take advantage of regulatory arbitrage. 

Understanding Regulatory Arbitrage 

Most of us, at least in a faint sense, have some understanding of arbitrage - the ability to take advantage of opportunities afforded when the same asset is priced differently in two or more markets. We are used to thinking about arbitrage in financial terms: you buy an asset for $100 in one market and sell it for more in another, pocketing the difference. 

Apart from financial arbitrage, there is also regulatory arbitrage: the opportunity afforded to regions or countries with regulations which are friendly to a particular industry. A classic example of this is companies setting up corporate headquarters in jurisdictions with little or no corporate taxation. Of course, not all regulatory arbitrage involves taxation, and the lighter the physical footprint of the business, the more arbitrage opportunities exist. 

Thomas Friedman may have written The World Is Flat nearly 20 years ago, but even he would have a hard time imagining just how quickly the barriers to a global workforce have been dismantled. Nowhere is this more true than with people and projects working with blockchain-based technology, where it’s common to have project teams spread across the globe. Apart from using many web2 tools to optimize async work, there are even crypto-native tools designed specifically for global coordination, and that’s not taking into account the borderless magic internet money that pays for much of these activities. Many digital assets projects don’t even yet claim a home jurisdiction for business purposes, operating as a sort of supranational digital organization. 

Very few industries have a lighter footprint than blockchain.

The U.S. Must Regulate To Compete

Against this backdrop, the U.S. and other countries who wish to compete to attract both blockchain-based startups and more established projects must create comprehensive regulatory frameworks for digital assets. This may sound counterintuitive, and downright antithetical to the cypherpunk ideal of privacy and anonymity on which the blockchain was built, but in a global crypto regulatory landscape that ranges from outright bans to red-carpet welcome mats, the countries with the clearest set of regulations will attract the most businesses.

The U.S. may have the murkiest regulatory landscape of all and it’s hard to tell whether it’s intentional or the result of some systemic ailment. Regardless, companies are leaving, and even industry champion Coinbase may be able to hold out for only so long. Even so, Coinbase is suing the SEC for regulatory clarity, but the SEC says it need not create new rules and that any new rules will take a long time to promulgate:

Knowing that the SEC enforces the laws created by Congress, forward-thinking legislators are introducing comprehensive crypto regulations in the U.S., but there’s no real clear sense that any have a chance of passing the House and Senate, let alone being signed into law by a largely anti-crypto President. In that sense the SEC may be right that rules are a long time coming, because there does not appear to be the political will in Washington D.C. to create a comprehensive regulatory framework for digital assets. 

It’s coming into election season for 2024, and political winds are fickle. With some major candidates running, in part, on a clear anti-crypto platform, things may seem bleak. But we may yet see Congress unify around a shared sense of purpose to ensure that the U.S. retains its global internet technological dominance earned during the past 60 years. The U.S. took the lead in building the early iterations of the internet, and it’s up to Washington to determine whether the U.S. will fight to continue to lead, or whether it will decide to cede its position as the world’s web3 innovation hub. The choice, or lack thereof, is clear. 

Hiro Kennelly is a writer, editor, and coordinator at BanklessDAO, an Associate at Bankless Consulting, and is still a DAOpunk.