China (and Other Nations) May Be Winning the Blockchain Race Against the U.S.

I recently read a great article in Politico by Brandon Possin, a U.S. foreign service officer (and friend of my colleague Fred Rocafort) who is currently stationed at the U.S. embassy in Tokyo. Possin also has significant blockchain-related credentials. In U.S. Diplomat to Washington: You’re Becoming Obsolete in One Big Area of Tech Policy, he describes how a number of countries, including China, continue to provide fertile ground to their homegrown web3 entrepreneurs, while Washington dithers and allows entrenched financial players to stifle innovation.

Do I Really Have the Tech Chops to Talk About This?

Actually, I do. As a pragmatic lawyer and businessperson involved with many blockchain clients and projects, I can confidently say that Possin is not wrong. I am part of the earliest generation in the U.S. that was born into a fully analog world but quickly forced to become digital natives. (One of my earliest regrets was not being smart enough to claim as my first email address).

I remember my father teaching me how to load Caverns of Gink and Bouncing Babies from “real” 5 ¼” floppy disks in 1985. From there I progressed to all kinds of Apogee games, then to MUDding, where I was routinely chastised by my parents for tying up our only phone line with our new “screaming fast” 28.8 kbps modem that I bought with my own money and installed myself.

And I remember fondly when my friend (who had two phone lines at his house) triumphantly showed me the two DVDs where he had burned a bootlegged copy of The Matrix after taking 24 hours to download it through a torrent site. And who can forget the joy of using broadband internet for the first time at a college computer lab to download any song in the world with Napster?

In my early 20s, my Linux-loving brother-in-law convinced me to dump Windows for Ubuntu, which I then installed. These technologies were often well outside the mainstream, and I enjoyed utilizing these tools to see what I could learn and accomplish with minimal outside guides. Being involved with blockchain projects has allowed me to relive the excitement and sometimes bewilderment of those key moments of discovery in my life.

Not Everything Blockchain Belongs Under the Crypto Headline

Possin rightly identifies the initial problem that seems to be rampant in the US: the ability or willingness to parse the various types of blockchain-related technologies. Not all of these are created equal, which cuts both ways. Peer-to-peer (P2P) software like BitTorrent and Napster emerged decades ago and fostered many derivatives. Generally, they have been the tools of those who  operate outside the law, or at least in grey areas where licensing terms and conditions are not robust or applicable.

From my vantage point, the foundation of which was largely informed by my time at FINRA (the Financial Industry Regulatory Authority), most of the recent SEC enforcement actions have centered around fraud schemes and “worst practices” common to private and public ventures and capital markets. These include unregistered offerings and sales of crypto asset securities, market manipulation through wash trading, undisclosed celebrity promoter relationships, and rug pulls, among others.

The SEC’s high-profile “regulation by enforcement” actions have not helped to provide any significant clarity or certainty to those inside or outside the web3 industry. I have my own opinion regarding whether staking should be classified as a security, and it starts and ends with “it depends” based on the facts and circumstances. But even well-reasoned legal opinions are merely opinions that provide only some comfort to founders and their prospective funders and business partners.

The SEC’s actions (and the CFTC’s sometimes contradictory opinions) regarding some of these key blockchain technologies and innovations continue to push founders and projects offshore to friendlier jurisdictions. For US founders, this means looking to Switzerland, Liechtenstein, Dubai, Portugal, Bahamas, Caymans, or Panama, and for China and Japan founders, this means looking to Singapore, Bali, or Dubai.

Blockchain’s Bloom is Not Doomed to Fade and Fall into Obscurity

Many of my web3 clients are nominally in the “crypto” industry, but in reality they are software developers working on innovative solutions that utilize some aspect of blockchain technology. They are crypto-adjacent, but not the type of bad players that are making headlines today (see FTX Founder Sam Bankman-Fried Charged with Bribing Chinese Officials).

These entrepreneurs provide tools to help the industry and are feverishly trying to make their software comply with existing regulations, often requiring geofencing users or creating two versions of their software, depending on where it will be deployed. This is true for founders and teams in the US, Canada, China, Indonesia, and elsewhere.

These developers and founders have retrenched during the crypto winter, keeping their heads down and their fingers on their keyboards. They are also painstakingly documenting the political winds in the US. Many of them are brilliant and looking for a safe haven. They are agnostic regarding their ultimate country of nationality and living quarters. They are part of the group who views their original nationality and citizenship as secondary to their identity as technologists.

Too Many in the US Government are Clinging to the Past

This goes for national and subnational governments. I’ll give just two examples. Many real property records are managed at the county level in each US state. These systems are woefully outdated, inadequate, and inconsistent. And they are not built for the type of forward-thinking projects such as tokenizing real estate that could help property owners monetize some or all of their otherwise unproductive real estate assets.

One significant hurdle to tokenizing real estate is complying with securities laws. But many US states have securities exemptions for securities secured by real estate. Harmonizing and updating these various state securities exemptions could unlock significant potential for real property owners, while allowing non-accredited investors to participate in this newly unlocked asset class. This would allow oversight by state regulators, many of whom appear to have a more robust appetite for blockchain innovations. See DAO Gets Legal Recognition in the US as Utah Dao Act Passes.

Tech-friendly Japan’s experimenting with DAOs (decentralized autonomous organizations) for rural regions is a second use case to streamlining widespread group participation via ubiquitous cell phones. DAOs can bring technology-enabled voting and asset distribution to longstanding but non-technically native agricultural collectives and similar rural groups, even those outside of the for-profit realm.

China’s Government Squashed Crypto

No, the CCP (mostly) squashed proof of work crypto mining (targeting Bitcoin mining’s energy-intensive process) in late 2021. Still, many of the CEOs of China’s promising web3 projects of all sorts relocated to Singapore and Bali as a result, and they stay friendly with the Chinese government the same way Chinese gaming companies do. They run their business, pay their taxes, and employ people generally compliantly (via “calculated noncompliance” – my term of art), rolling the dice the same way many Chinese and foreign companies do in China.

The CCP’s big brother role waxes and wanes, dictating at various times how, when, and for how long Chinese citizens can, should, or shouldn’t spend their time and express their opinions online. But the CCP doesn’t care whether non-Chinese youth are mesmerized (addicted) and divulge their secrets on TikTok, Honor of Kings, or Clash of Clans, as long as these projects keep people working in stable jobs in China. Blockchain ventures are no different.

The Chinese Government Supports Blockchain Innovation and is Molding Web3 in Its Image

China has made significant strides in trying to resurrect its domestic economy. This includes touting Hong Kong as a web3 haven. However, Hong Kong is not Singapore and it is not far enough removed from the CCP’s influence. Many blockchain founders, especially those with China ties who are clearly operating outside of Chinese law, need that separation. This is especially true for those deeply involved in cryptocurrency exchanges that can fast-track capital flight out of China. But Chinese founders from the mainland may be willing to set up in Hong Kong, somewhat bolstering Hong Kong’s image as a resurgent financial capital.

I am concerned that China could require its exporting companies of all stripes to use natively built dApps (distributed apps) in closed-loop or permissioned blockchains that effectively put a web3 sheen on the software while furthering the CCP’s oversight through backdoor channels.

AI News is Crowding Out Positive Blockchain Development News

The release of ChatGPT in November 2022 was one of the best and worst things to happen to the blockchain industry. AI forced its way into the high-tech limelight that was formerly primarily occupied with web3 news, including that Baidu’s response to ChatGPT was years behind it in development.

In the wake of ChatGPT’s release, some interesting questions were raised by China scholars about the corpus of information that AI programs in China would be trained on, and whether those certainly redacted data sets would limit their effectiveness. Robust AI programs require unbridled access to information to explain the present or predict the future. These and other AI-related questions and developments, along with negative blockchain news, have generally crested reporting on positive web3 developments.

We Need a Sandbox, and We Need It Now

What are we supposed to do about all this? Regulatory sandboxes are being utilized by many governments, especially regarding the fast-paced interaction of technology with other more traditional areas, such as finance, real estate, and anything else under the sun. That is the genius of regulatory sandboxes. They provide much-needed regulatory oversight without stifling innovation in areas where technologists want to run.

Rather than continuing to regulate by enforcement, the SEC should work together with the CFTC and Congress to provide a creative workspace for blockchain projects as a natural precursor to legislation and regulations that will be informed by the developments in a regulatory sandbox.