U.S. Regulation of Cryptocurrency Exchanges

Yesterday the chairs of the Securities and Exchange Commission and the Commodity Futures Trading Commission testified before the Senate Banking, Housing and Urban Affairs Committee about the role of federal regulators over virtual currency.

I communicated out to a few friends: "Look for the US to regulate "spot market" exchanges (centralized exchanges like Poloniex). The strategy will be to bring crypto exchanges into the centrally regulated/controlled markets."

Someone responded with what I think was a good question: "Is this good or bad? Probably bad."

My response went as follows:

I'm for the government regulating centralized crypto exchanges (like Poloniex). I think that would be a good thing. It is already happening in the U.S. with AML, KYC regulations. China just flat-out made it illegal.

If it is a centralized trading business, then it should be regulated like all the others NYSE, NASDAQ, NYMEX, COMEX, etc.

Don't get me wrong, I do not believe that such regulation is efficient nor effective!

I think this is a natural response for the government. However, most individuals working for the government don't understand how decentralized peer-to-peer (p2p) systems work. So they don't realize that they can't regulate a decentralized p2p cryptocurrency. They can regulate centralized exchanges that enable the trading of tokens, but those are not the decentralized p2p systems. Those centralized exchanges are external to the decentralized p2p networks.

Centralized governance is not a supported pattern for decentralized systems. If you attempt a centralized governance (i.e., regulation) scheme in a decentralized system, the system will fail. However, most exchanges have been built by client/server guys who don't understand decentralized systems. Therefore the majority of exchanges people trade cryptos on today are centralized exchanges. The U.S. government can and most probably will attempt to place these centralized crypto exchanges under regulation.

Given, where we are today I would welcome that because it should accelerate the proliferation of decentralized p2p exchanges and those can't be regulated by State actors. It would be the foundation of a digital free market. Regulation on decentralized p2p exchanges should be regulated by contract law, implemented in code (what some refer to as smart contracts) and automated (implicit in the trade process). A working example of this is the Bitshares platform.

The decentralized p2p free markets will require governance (a.k.a. regulation), however, this will provide us with an evolution in how such governance is implemented by substituting reliance on the State and relying instead on explicit terms and conditions packaged in contracts enforced by mathematical principles. Trust in math, not State bureaucrats. It will also reintroduce the idea of personal responsibility moving us away from dependence on the State.

So in summary, I think its good because, it will accelerate our move away from centralized client/server architecture towards robust decentralized, p2p architecture. Then the question of centralized State provided regulation will become less and less relevant.

Make sense?