On Regulation of Crypto Assets

Dear Financial Regulators,

Please step-up your work in the area of crypto assets. Easy access to uncurated funding feeds low-quality ideas and fraud. To help your work, we’ve included a few emphatic proposals, to aid in your decision-making process and whet your appetite for the same.

Scavenge Exchanges

First and foremost, please start with regulating the exchanges in the full sense of the word. Regulation policies cannot apply to some and not apply to others — we must either recognize an institution in full or it cannot exist and operate in the same sphere. Grey zones are a shame which weaken the whole supposed field of regulation.

We need our accounts to be fully secure and government-insured, preferably. No banks should reject services for using regulated crypto exchanges — it’s quite frankly, humiliating. Please put an end to pump-and-dump practices, track down inside traders and throw them in jail.

Most importantly, please control the exchanges properly, asset by asset. Stock markets are controlled; there are strict regulations which don’t vary from one stock to the next. Please, do the same with crypto assets. Speculation with pseudo-crypto assets wastes investors’ money, which otherwise could support valuable engineering. It also misleads newcomers and generally spoils the emotional climate of the community.

For a decent business, registering its securities issuance with authorities is not an issue. It’s a complex product that cannot be sold without guidance, as consumers have zero chance to crunch sufficient information by themselves.

If your business wants to sell some sort of investment tokens instead of traditional securities, it doesn’t change the essence of the deal: the sale should be properly supervised, the rules should be clear.

We believe that tokens are not securities, tokens are not commodities, tokens are not currencies; they are what they are — tokens, and their sale must be regulated. So when that happens, it happens. There’s nothing wrong about it.

The bad thing is that token scams are so successful because they exploit this fake affinity to securities.

On one hand, liquidity provision tools (crypto exchanges) play an important role. In their essence, most ICOs simply channel the wealth from late buyers to early buyers which makes them a sort of Ponzi schemes. First they deploy “pre-sales”, price discounts, “cups” (maximum to be sold with amount actually sold being unverifiable), artificial scarcity (one time emission only), limited time offer (one month long event), etc. Participants then help to create hype through their social channels for free because they need “to pump the coin”, so they can sell with profit once it “hits exchanges”. As tokens distributed during the ICO change hands on exchanges, organisers have less and less people to feel direct responsibility to.

On another hand, amazingly, regulators play in favour of scammers too. Their “are tokens security?” narrative puts the two very different phenomena on the same scene and actually helps to legitimise the fraudulent practice of ICOs in the publics’ eyes. Scammers pretend to “be concerned about potential violation of securities regulations”. However, that is a huge untapped honour because what they commit is an ordinary crime of running a Ponzi scheme, not a “noble act of an innovative crypto anarchist to fail registering a security with ruthless government”.

Reveal Purpose of Assets

Maybe you are not sure what assets to start with, and, of course, you have limited manpower. No problem. Consider opening a formal petition tabling web resource and start with assessing the assets that collect at least a few millions votes. You can always lower the threshold ones the initial rush is over.

Assessments are going to be a creativity demanding job. We’d recommend starting with a set of criteria defining whether or not an asset is a crypto at all. Look at the purpose of an asset. “Blockchain-based”, for example, is really a silly criteria — the Mars rover, suitcase, and hamster all use wheels but that doesn’t put the three into any same category of things. At this step, you will be able to filter out the most shameful and purposeless assets.

Classifying crypto assets by their core purpose is natural and essential; it must be at the very beginning of the process to regulate the same. It explains the most about the asset in the shortest path possible; however, note that over time, patterns of usage may change, fork, granulate.

For example, Bitcoin was sequentially used a as a libertarian position statement, a gambling token, a store of value, a hedging tool, a value transportation tool (sort of payments, but not exactly), and a convenient escrow collateral. Soon, with broad Lightning Network deployment, it may come to commerce for real and its purpose set will fork, pivot, and grow again.

Delexicon of the Term “Crypto Currency”

Crypto currency is an incorrect term with a misleading narrative. Claiming to be a currency, crypto or not? As soon as confronted with the economy, it runs. Period. And, let’s be honest. Coherent and consistent believers of Hayekian properties should not even bother applying for an exchange listing in the first place — they should only care about their community’s economy, not rates to the “pre-mined” US dollar.

This “crypto currency” term paints crypto enthusiasts as naive and aggressive anti-fiat conspiracy adepts. That’s harmful. The best professionals — those who could help in strategic crypto development — do not even approach the industry sector. Who’s there instead? A ton of scammers and weirdos looking to cash in on other people’s misfortune. Why do you think user experience and customer support of literally all crypto-related services sucks so much? High demand? No! The demand was high even before the hype. So why is it? Well, simply put, we get the worst type of marginal entrepreneurs.

While many economies suffer from corrupt practices in the banking and payments sectors, fiat currency in and of itself represents not a problem, but a solution. The mourned gold standard was a very short experiment, in historical terms, and it has failed. Today, currencies are deliberately soft, they are the tool that runs economies, they are something that is specifically, wilfully designed not to “grow”, but rather to create an ongoing incentive to spend. Small inflation is not a problem — it is actually an ideal and the desired state of things. Hyperinflation is never caused by economic, and even less so currency diseases; it is always a result of a political cancer.

Of course, even if wrongly named at the edge of an insult, inherently good things will find their ways to the top. Bitcoin, for example, has been nurtured through a stage when it was still possible to be destroyed by a niche group of escapist libertarians and some undereducated conspiracy believers. It is not the first time something of a great value appeared as a result of a fundamental mistake — the entire America was discovered that way.

Scrutinize Claims of Decentralization

“Decentralize something” is a legit purpose, but only for things that are worth becoming public domains and that will succeed in doing the same. The requirements to qualify for this category must be fastidious: to become a public domain, a system behind a considered asset must have some substantial user base, a sizeable history of development and maintenance, and structural quality assessments done by recognized professionals.

Consider a national park — it’s not something that is randomly assigned. Similarly, there must be a clear criterium as to why a particular application needs a version for the commons. For example, it is easy to see why a file storage or credit rating should have a publicly run ownerless alternative; however, most decentralization claims marketed by ICOs are clearly ridiculous. In any case, regulators don’t need to be petty tyrants — the user base size filter will do the most of the job.

By the way, public domains have to be protected. Your colleagues in other governing bodies make sure no one contaminates tap water. In the same vein, why do you allow various freaks to spoil the Bitcoin image and steal its good name? The core attribute of Bitcoin is to be trusted by the public — one can’t mess with it.

“Public domain” is a very demanding status. Before you hand it out, you should make sure the considered system needs a freely traded asset. For example, the founders of smart contract platforms claim their asset is needed to protect the network from spam and for other reasons. But don’t only accept their word for it — even that has to be verified. This is the early stage at which you can filter out most of the impostors. The next question is just as important: even if the asset is proven to be necessary, does the system’s purpose really imply the need for people to gamble it? Why not maintain the price through some more administrative instruments? Not every functional valuation in this world happens through open market trading.

Help Honest Tokenization

Tokenization is a way to securely account for things and harmonize supply chains. We use tokens every day, everywhere: keys, invoices, receipts, tickets, etc. Crypto tokens are just more convenient, more secure at low cost, and — unlike our current various tokens — they can be compatible, globally.

Myriads of businesses can — and should — be tokenized; after all, that is the legit purpose to have a traded token in the first place. So, you should request those who want to list a token on an exchange to present the application and see if it works. Do people actually use it? Do the tokens fully reflect the claimed technical specifications? Formally speaking, tokenization is the process of substituting sensitive data elements with non-sensitive equivalents that can be operated anywhere outside of the original data custody domains. So, simply ask the founders to show the sensitive data domain — what is for your eyes only? After the demonstration, I’m pretty sure the deliberation will be clear. Of course, the vast majority of ICOs will die right there, on the spot — they’ve got nothing to show.

Oh, and one more thing. Tokenization projects can’t come as stand-alones, they need to emerge in alliances.

Administer All Product-less ICOs as Crowdfunding

One very large category of crypto assets includes projects with nothing real in hand, but a vocal crowdfunding effort. When we say “nothing real” we mean that in most cases, it’s even missing an original idea. Everyone in this world starts from zero, but not everyone wants to sell that zero for real money on day one. They also want to be listed on regulated exchanges, especially once you’ve ensured there are no others, unregulated ones around.

When applying for an exchange listing, what these flounders are essentially asking you for is to allow them to bypass the normal competition for “smart capital” and grab some “dumb investment money”. Can you understand how wrong that is? It’s often presented as avoiding the VC or IPO bureaucracy, saving money on lawyers, but that’s a lie. It may have been true in the age of the first ICOs — now you still have to spend a few hundred thousand dollars on ICO marketers who are just as much of a parasite as lawyers. So, when assessing an asset, you are mostly trying to answer, “Does the public need you to grant that sort of indulgence to someone? Will that help finance some valuable ideas and teams that for some reasons could not be funded through normal channels?” Maybe so, maybe not. To help you decide, let’s recall how it all developed.

History of Envying Bitcoin’s Success

At the dawn of the Age of Discovery, a very specific market has emerged. People with some money would hire some daredevils and wannabe-pioneers with the instruction: “Sail over there somewhere and discover something; bring me gold”.

This is similar to the market of ICO white paper writing today. In most cases, the originator simply decides to cash out on something, quickly. He has no clue about the technology and usually has only a very vague idea what segment of business he wants “to put on a blockchain”. And he almost never can explain why, so he hires a white paper writer.

No, wait… this discovery analogy softens the reality. Let me give a more precise illustration.

It’s 1873. J.C. Maxwell unites many known phenomena into a single field and force. Suddenly, electromagnetism equations open up a whole new dimension of understanding nature. Any similarly significant discoveries, where new physical interactions will be described, are decades away. And those forces (weak and strong nuclear) will not be used in any “consumer application” for hundreds of years, maybe more.

Now imagine crowds of miserable entrepreneurs in late 1870s, agitated by Maxwell’s work, seeking to hire “new field discoverers” and “scientific paper writers”. They find them — the money-backed demand rarely passes unmet! Few sober people take practical steps and on further develop of Maxwell’s work, they bring electricity to our homes. But the majority would try to “re-invent” or “invent something just like that”. Now of course, this is not how it was back, then but this is exactly what is happening all these years after the creation of Bitcoin.

One large chunk of ICOs exist to “disrupt the global finance”. Why? Presumably, because they think Bitcoin has something to do with finance, since it is “p2p cash”. We have many “currencies”, lots of “asset managements”, and even “blockchain banking”. Do I need to remind you that it has been almost 10 years and, yet, absolutely nothing from that segment is used in real business?

Another historically big fraction of ICOs is “platforms”. They take another approach to re-invent Bitcoin: they try to make it “more universal” and “correct its mistakes”. We can compare these people with those who would have tried to re-write Maxwell’s equations. Actually, the equations were re-written, for example, into the complex numbers form which is more laconic and beautiful. Did it make it any faster for people to have their homes electrified? No, it didn’t even speed it up by a day.

Some platforms’ white papers are more interesting to read than Satoshi’s original, but that’s a natural progression. New authors have more analytical data. Of course, new platforms are easier to use, easier with each iteration and evolution; however, we doubt it is a good thing, considering the circumstances.

When reading any of those papers, the strong feeling remains: the authors have little idea what their platform will be used for. Of course, they will host applications. But, as years pass, there’s a growing concern that very few blockchain-based applications are better than their incumbent rivals.

Blockchain will transform the world, but not by repeating existing centralized systems in a decentralized way. Our guess is that the decentralization trend and “trust in math, not in people” idea is seriously overstated. The blockchain world will merely tokenize the economic calculus, optimizing a lot of stuff without revolutionizing the basic socio-political platforms. Ubiquitous compatible tokenization is the phenomenon that we just don’t have the analogy for today.

People started to look at Bitcoin in a more abstract manner and, instead of copying or “improving”, tried to look around where some of its ideas, not all, could be applied — new meaningful ideas emerged with chances of surpass the incumbents. Some of them are:

• more consensus, tokenized prediction markets (Augur),
• “proof-of-contribution”, distributed file storage (Filecoin),
• tokenization plus gamification gave life to the new crowdsourcing science (Adtoken),
• ubiquitous tokenization builds optimal supply chains (Sweetbridge).

The list is obviously longer, but not by much. And, of course, everybody has their own variant. What we want to draw your attention to is that many apps on the list are not actually stand-alone, but hosted on a platform. (So far, it is Ethereum in all cases but that will change very soon.) The overall pattern is quite sad. Currently, there are very few meaningful applications and each one of them makes more sense than the platform they are built on. It doesn’t look like we need more platforms before we see some real contours of tokenization. Platform creation feels like a premature activity. We suppose good apps will eventually leave their current platforms. Partly because they will need to optimize to the bordering conditions of the app, and partly because they will not want to remain neighbours to thousands of generic projects, whom Ethereum and other platforms made so easy to replicate, with this kind of pitch:

“Before us, throughout thousand of years of history, governments and rulers have had formal relations with religious organizations, political parties, commercial companies, and later, with non-profit formations. Every group of people united by one goal could always fit into one of those categories. Until recently. We are new and we are none of those. We are a self-sufficient closed-loop crypto-economy. We have to be treated, regulated, and even taxed differently. We are like a “new country”. For _____ (insert an industry sector, like dentists or whatever). Everyone can become a “citizen”. We will build new land in the ocean, we will seize the land from old countries. Before we do that, we are selling millions of our “passports” (tokens) to whoever wants to buy. We even allow them to sell passports to each other and help them drive the price up. People will buy passports because we use blockchain.”

Dear Financial Regulators,

We could survive without you regulating bitcoins and few other organically-introduced assets that make sense. Honestly speaking, we’d avoid you, by all means. We’d just use billboards for OTC exchange; we’d make distributed exchanges work.

But now, with thousands of ICOs that have delivered nothing, we have a polluted home. The backlash to this situation is not only going to be social — it may enter the real politics category. Today, as it’s a very real possibility that the crypto community could die from “choking with its own vomit”, we need you, and fast.