Now that the global cryptocurrency marketplace has experienced its first boom-and-bust cycle, it is the perfect time for critics and believers alike to reflect on the lessons learned and establish principles to ensure that decentralized finance can mature into a useful and long-lasting element of modern society.
At this critical juncture, ensuring full realization of the "DeFi" revolution will require the creation of a well-equipped nongovernmental self-regulatory organization, or SRO, charged with ensuring system security, privacy, and stability while building trust among regulators and the general public.
While some in the digital-asset space have strongly resisted any sort of governmental interaction and oversight, it is now apparent that for digital currencies to become ubiquitous, some degree of coordination with policymakers is necessary to draw bright lines between legitimate crypto activities and the existing federal banking system.
Since it is highly unlikely that federal regulators will sit back and allow the crypto industry to remain largely unregulated, a preemptive move to establish an SRO could bring some necessary safeguards into the system while holding off burdensome intrusion from the federal government which would jeopardize the entire crypto project.
An SRO could be conceived as a proactive buffer between crypto users and federal regulators to maintain an appropriate balance between privacy and security. This function could also prevent systematic government surveillance or interference with the private financial activities occurring over blockchains, while ensuring that regulators can only access account and payment information with warrants delivered by the check and balance of the judicial system.
The concept of a SRO is not new to finance, or indeed to crypto.
The securities industry long ago worked with policymakers to create the Financial Industry Regulatory Authority and the National Futures Association, which have proven to be highly functional and reliable models. Indeed, there have been a handful of attempts at forming cryptocurrency SROs, most notably the Virtual Commodities Agency proposed by the investors Cameron and Tyler Winklevoss, but none of these projects have gained traction to this point.
Any SRO that does materialize should be governed and staffed by people who deeply value decentralized finance and the importance of maintaining the free flow of commerce with minimal surveillance and control. At the same time, these staff must also understand the value of establishing a strong framework of rules and expectations as the latticework on which a flourishing crypto ecosystem can grow. We've all just seen what a crypto boom market looks like without this structure — it grows into a tangled mess of weeds that sags under its own weight, leaving many of its holders in financial hardship.
In an ideal marketplace where all participants fully understand and consent to the risks they are facing, there is limited public interest in regulating cryptocurrency, since members of the public not involved in this industry will be insulated from any material harm. Building this barrier will strongly reduce the need for government intervention, since the state only has oversight over public matters.
But this libertarian principle also works in reverse: Those who are truly committed to building a decentralized financial system should have no desire to seek government subsidy for their activities, such as using tax-exempt 401(k)s as a funding source, or accepting (and certainly not promoting!) federal deposit insurance. Finding an equilibrium between the need for some rules of the road, with the individual freedom and privacy provided by decentralized finance, will be the core challenge of this effort.
For digital currencies to succeed in the long run, they must ultimately become a reliable and widely used means of exchange, and this will only occur once both regulators and the public trust them as much or more than their existing payment options. Widespread adoption will also require acknowledging financial reality that it is difficult for financial units to function as both units of exchange and as appreciating stores of value. For currencies to be widely adopted, their values must remain stable since price fluctuations introduce uncertainty and create opportunities for destructive speculation.
While many existing cryptocurrencies have successfully used mining algorithms to solve the age-old problem of inflation-based devaluation, their widely swinging prices and inelastic supply have proven to be significant barriers to their use as payment mechanisms. As an additional benefit, the establishment of cryptocurrencies as reliable digital means of exchange, as opposed to appreciating investment securities, would significantly weaken the Securities and Exchange Commission's argument for inserting itself into this marketplace.
Previous attempts at forming a self-regulatory organization failed to materialize, as the enticing and unsustainably high returns of the first crypto period drew all attention away from serious attempts at developing a mature industry.
But now that crypto has completed its first cycle and come back to earth, this is the perfect time for this industry to take the necessary, if difficult, steps to ensure its long-term viability. Taking immediate action on these steps will also make them easier to accomplish, since the cryptocurrency market will only become more complicated as time passes.
It is more than possible for true believers in decentralized finance to build the latticework for cryptocurrencies to truly deliver the privacy and freedom that their founders envisioned.
