How and Why Blockchains will Massively Reduce Regulations or Their Relevance

It’s no exaggeration to say that, historically speaking at least, economies don’t run on money so much as they run on trust. When trust breaks down, businesses begin to doubt their counterparties. Consequently, they cease to venture, or at least venture much less. Risk taking evaporates, hoarding begins, demand for collateral skyrockets, the velocity of money plummets and the economy collapses. Jobs and fortunes are therefore lost.

Government as The Primary Source of Trust

To the extent that governments have done much good, it’s been a consequence of them fostering sufficient trust within their realms. In peaceful and prosperous nations, governments can be counted upon, for instance, to enforce private contracts and to diligently guard private property rights. In fact, doing these two things is a significant reason that governments even exists. Contract and property right enforcement is so important to the welfare of us all that we have historically been willing to grant governments a monopoly on the legitimate use of force in exchange for a promise that it will be applied in defense of property and contract rights.

But governments have done far more to foster trust within the realm than simply enforcing private property and contracts. In fact, a massive portion of the laws and regulations that governments have promulgated are intended to simply engender trust so that people and businesses will venture. Let’s ponder, for example, how much the government has sought to ensure and enforce trust just within a commercial and financial context.

Trust in Commerce

The government generally requires anyone engaging in a trust-based business (a business that maintains custody of other people’s assets, for instance) to be licensed or credentialed. Bank, brokerage firms, broker-dealers, exchanges, clearing houses, registrars, money transmitters, insurers, pawn shops, etc. must all generally be licensed because they take custody of client assets.

Why does that matter? Because holding other people’s assets opens up a vast number of opportunities for fraud. Fear of such fraud limits venturing, reduces the velocity of money, etc. Neither the government nor its people want that.

So, the government needs the public to feel confident that the people holding their assets for them are safe and trustworthy. Thus, the licensing requirements.

But the government obviously license just anyone. Proposed licensees must generally, among many others things, pass intrusive background checks, must demonstrate competence, and must put a significant portion of their own money at risk (that is, meet minimum capital requirements for licensing) before they are permitted to engage in these “trusted” businesses.

Likewise, people empowered to act on behalf of others (and especially if they can contractually bind others or if we depend upon them to execute our contracts)—for instance, commercial agents and fiduciaries of various sorts including attorneys, real estate agents, stockbrokers, trust companies, investment advisors, etc.—enjoy privileged positions of trust that similarly create opportunities for fraud. Consequently, its no surprise that they too must legally undergo background checks or other forms of diligence and be appropriately licensed or credentialed before legally conducting their respective businesses.

Further, the government does not permit these licensees to keep their books and records however they may. Rather, the government, at a minimum, usually requires double-entry bookkeeping (because it makes fraud much more difficult to accomplish and much easier to detect after being accomplished) and often prescribes certain consistent accounting methodologies or conventions for specific industries.

Further, the government does not allow these businesses to decide with their clients the standard of care that they will employ in handling client assets. Instead the government usually imposes the highest standard of care known to law—“fiduciary responsibility.”

And for those businesses with the greatest opportunity for fraud, the government goes much further. For instance, it will require annual CPA audits (at a minimum). For some, such as most financial institutions, it will in addition require periodic regulatory audits or inspections (conducted by bank examiners or other regulatory bodies or agencies such as the Federal Reserve, the FDIC, the Comptroller of the Currency, FINRA, the SEC, the Commodity Futures Trading Commission, state regulatory authorities, etc.).

But the government doesn’t stop there. To be assured that the CPA auditors are doing competent work and have not been corrupted, the government requires that CPA firms themselves be audited (“peer review”) every three years. And to be sure that the government inspecting agencies are likewise doing their job and have not been corrupted, they too (well, except for the Federal Reserve, oddly enough) are subjected to audit or inspection by, for example, the Government Accountability Office, various Inspector Generals within each agency, etc..

So now we have auditors auditing auditors and regulators regulating regulators, all for the purpose of engendering trust in the system.

But…There’s More!

Surely that is sufficient, right?

Nope. The government also subjects many of these licensees to regulatory filing requirements where they must affirmatively disclose to the government and/or the public information about themselves and their businesses and their finances. For instance, just to name two, banks must affirmatively demonstrate periodically that they meet regulatory minimum reserve requirements, and any publicly-traded company must make at least quarterly filings with the SEC regarding its financial condition.

So, surely that’s enough, right? After all, we have licensure requirements, bookkeeping requirements, minimum capital requirements, fiduciary requirements, disclosure requirements, filing requirements, audit requirements, etc. And we have auditors auditing the auditors and regulators regulating the regulators.

And More

But…no. In some cases we go even further. The government also created the FDIC and the SIPC, agencies that insure bank and securities deposits respectively, just in case, despite all of the above protections, fraud or incompetence still occurs.

And what if the FDIC or SIPC go bankrupt? Can’t I still lose the money that I placed on deposit with these “trusted” banks and brokerage firms?

Ah, no worries! The government backs those agencies with implicit governmental guarantees. All so the public can have as much confidence as humanly possible that their money is safe. All so that they will then venture and transact. All so that the velocity of money will increase or remain high. All so that the country will prosper and the politicians will get reelected.

In short, the governments impose all of THAT 👆🏼, and so very much more, just to engender sufficient trust within the realm!

Enter Blockchain

But imagine if a new technology came along that provided such security improvements and guaranteed that these “trusted” businesses were no longer needed, or at least much less important. Wouldn’t that make nearly all of the above regulations inapplicable and irrelevant?

I mean, what if money or other assets could be “locked” within computer programs (“blockchains”) reliably running on a worldwise distributed network of computers that can’t be hacked or censored, and that run in very consistent and predictable ways beyond the control of any person or entity or any feasible group of them, perfectly executing pre-determined instructions to which the parties have agreed?

And what if users could customize those programs to suit them, such that the money or other assets locked up in the blockchain are automatically and entirely reliably released by the program to the control of one or more of the parties only upon occurrence of certain pre-defined conditions agreed to by the parties? (E.g., the program is coded so that “upon the blockchain verifying by itself that I have placed title to my house in blockchain escrow for your benefit, the $1,000,000 that you previously escrowed on the blockchain as the purchase price for the house get’s automatically released to me, or vice versa”).

And what if you could on that same blockchain reliably transfer title to money or most any other asset from one person to another with the press of a few buttons?

And what if that blockchain was transperent but anonymous, so that every transaction could be viewed and confirmed by anyone in real time without necessarily exposing the identity of the parties to the transaction?

In such a world, wouldn’t all those regulations be mostly unnecessary or irrelevant? Of course they would!

Meaningless Regs

Since assets can now be custodied and transferred on a blockchain, and since those assets are controlled by nobody (only the program that we ourselves write or agree to), we no longer need to rely upon trusted, licensed, capitalized intermediaries to custody or transfer assets. We can escrow assets on the blockchain where nobody can steal them or lose them or bankrupt while holding them. We can post collateral on the blockchain without the need to trust a custodian or escrow agent. We can transfer title to assets on the blockchain rather than on the books and records of some licensed intermediary.

Capital and reserve requirements therefore become mostly moot. Likewise, since the blockchain does all of the accounting automatically and perfectly reliably, there’s less need for governments to dictate accounting conventions or methodologies. The accounting can be done however the parties agree so long as its consistent with the basic rules of the blockchain.

Further, since nobody can steal blockchain assets and all contracts on the blockchain are self executing and completely transparent, we don’t need to vet and license custodians for them. In fact, there’s not even any human to license! The assets are simply held in a computer program agreed to in advance by the parties that can’t be gamed and that executes the programmed agreement perfectly reliably.

And, we likewise don’t need to audit or examine the blockchain custodian programs, both because they execute agreements automatically, transparently and perfectly reliably and because the blockchain transactions themselves can be monitored in real time by anyone.

And, because anyone and everyone can monitor things on a blockchain in real time, there’s no need for periodic filing requirements. Banks, brokerage firms and trust companies can conclusively prove their income, assets, and reserves to regulators or customers second-by-second by reference to the blockchain. Via blockchain-enabled supply chains, we can tell with absolute certainty, for instance, that “x” dollars of the accounts receivable on Company A’s books does in fact tie exactly to “x” collars of accounts payable on Company B’s books, and so on all the way up or down the supply chain, eliminating one of the most common forms of accounting fraud (invented purchase/sales invoices). This has sometimes been referred to as “triple entry bookkeeping”, and, like double-entry bookkeeping that preceded it, it will be a massive, massive leap forward in fraud prevention and detection.

As discussed at length in this video (starting at about the 55 minute mark), blockchain-enabled triple-entry bookkeeping has another very important effect. It enables individual and businesses to make instantly liquid assets that usually are not (e.g., their accounts receivable, excess inventory, real estate, etc.).

And since we need fewer auditors and regulators, we also need fewer auditors of auditors and regulators of regulators.

And since so many contracts ( often called “smart contracts”) are self-executing and self-enforcing on the blockchain, breach of contract becomes much more difficult and less likely. Consequently, we need rely upon the King’s court’s much less to remedy breaches.

Conclusion

In short, when most all types of assets can be reliably custodied and escrowed on blockchains, a day that is quickly approaching, a very substantial portion of our regulatory infrastructure becomes moot. The cost savings to society and to governments is consequently massive.