Regulation, useless dapps & the thin line between.

Sat Feb 9 2019 · 6 minute read

“I can’t speak for what Satoshi intended, but I sure don’t think it involved bitcoin exchanges that have draconian rules about KYC, AML, passports, freezes on accounts and laws about reporting “suspicious activity” to the local secret police. There’s a real possibility that all the noise about “governance,” “regulation” and “blockchain” will effectively create a surveillance state, a dossier society.” - Timothy C. May 1

New wine & old skins

On the 10th of Feb 2019 the SEC (The United States body responsible for regulating financial instruments) announced its “Our guide to initial coin offerings” I found the documentation to be vague as it contained statements like, “ICOs, based on specific facts, may be securities offerings, and fall under the SEC’s jurisdiction of enforcing federal securities laws.” The statement does not proceed to further outline the “specific facts” that make a token (ICO) a security. 2

To me, this looks like a recurring variant of governments saying “It is what we say it is” to leave options open so as to play on semantics in case members the “Deep State” needs to pursue its personal interests3. This can also be because I am not a legal expert.

The SEC however, has a “litmus test” used for determining if a financial instrument is security (i.e) if it falls “..under the SEC’s jurisdiction of enforcing federal securities laws.” It goes by the name “The Howey Test”. According to the SEC, a financial instrument passes the “Howey Test” if it satisfies all these;

  1. There is a person (investor) investing the financial instrument i.e creation of an “investment contract”
  2. The person (investor) expects to profit from investing in this financial instrument i.e “speculation”
  3. The profits expected in “2” above are “..derived from the managerial efforts of others..” who are commonly vested in the same financial instrument.4

My problem with the SEC’s approach is not that regulation is bad. My argument is that the financial sector has changed a bit and using 72 year old case (SEC v. Howey Co. case was decided in 1946)5 & to solve current regulatory issues in the bleeding edge fintech space with tokens, smart contracts that work trustlessly on a global scale, is like pouring new wine (10 year old blockchain driven financial instruments) in to old skin (72 year regulation). Hence a classic remedy to , a disaster.6

Introducing Szabo’s law

“The more kinds of decisions there are to argue over, the less functional the institution will be.” - Nick Szabo7

One of the interpretations of Szabo’s law is, “Do not implement changes to the blockchain protocol unless the changes are required for the purpose of technical maintenance.”8

I find Szabo’s law valid in the sense that, inviting regulators like the SEC to modify blockchain protocol’s so they can be “compliant” with 72 year old case is a mistake.

Making a blockchain protocol “compliant” means;

The value proposition of blockchains is to work for anyone anywhere without the limitations above, and the ability for blockchains to work like this is called social scalability.11

Adding legal compliance to blockchain protocols hurts social scalability & a fair translation of “compliant blockchains” above can as well mean “breaking a blockchain protocol”.

Useless Dapps

Dapps or Decentralized applications are basically software deployed on blockchains instead of traditional infrastructure like Cloud (Amazon Web Services, Google Cloud, VPS, Shared hosting). This decision is taken so as to leverage upon the value proposition of the blockchain (financial instruments that work for anyone, anywhere).

Dapps that don’t scale socially are useless.

Examples of useless Dapps;

USDC by Coinbase is a unit of account on the blockchain that allows US dollar transactions on the blockchain by allowing it to be redeemable to bank wired US dollars. USDC how ever has parameters in the code that allows confiscations to be made from any user at any point in time.12

DX.exchange wants to distribute securities (Google, Facebook, Apple & Tesla Stock) via the blockchain. The service however is only available to millionaires13 so as to comply with accredited investor rules of the United States. It also blocks several countries from accessing the service in attempts to comply regulation. 14

DutchX from Gnosis claimed to be a decentralized exchange that allows trustlessly swapping of digital assets via Dutch Auction.15 DutchX however blocked about a dozen countries from accessing its service. 16

Conclusion

Szabo’s law is the thin line that separates useful blockchain applications from useless ones.

FOOTNOTES


  1. Timothy C. May, author of the The Crypto Anarchist Manifesto wrote this in an article for Coindesk. [return]
  2. The SEC, (abbreviation for Securities Exchange) made this announcement via Twitter. However, the documentation they point to indicates that it was was modified about 3 days before the tweet i.e on the Feb. 7, 2019 (at the time of this writing). [return]
  3. I am of the opinion that every country (a part from Switzerland of course), has a narrow group of elites that often manipulate governments in order to achieve their selfish interests. [return]
  4. This is a very simplified overview of the Howey Test & may not even be accurate as I am not a legal expert. [return]
  5. 72 years at the time of this writing. [return]
  6. “New Wine into Old Wine skins” is a parable by Jesus in Luke 5:37 that says “No one puts new wine into old wine skins, or else the new wine will burst the skins, and it will be spilled, and the skins will be destroyed”. [return]
  7. I extracted this from a tweet Nick Szabo made in 2018 [return]
  8. This seems to be @CleanAPP’s description of Szabo’s law, even though Nick Szabo didn’t say such a thing a thing at any point in time. [return]
  9. It’s illegal for US based companies to provide services to entities on the US sanction list. Slack users experienced this first hand [return]
  10. Americans for instance had their gold confiscated in the 1930’s & the same happened to Indians in 2016 [return]
  11. “Social scalability is the ability of an institution –- a relationship or shared endeavor, in which multiple people repeatedly participate, and featuring customs, rules, or other features which constrain or motivate participants’ behaviors – to overcome shortcomings in human minds and in the motivating or constraining aspects of said institution that limit who or how many can successfully participate” – Nick Szabo [return]
  12. “Circle can Freeze your USDC if One Violates Circle’s User Agreement” CoinGape [return]
  13. Who is an Accredited Investor? – Educational content from the SEC [return]
  14. After a bombastic PR launch on Bloomberg I decided to test the service, only to realise my IP was blocked. [return]
  15. “Dutch auction” from Wikipedia [return]
  16. I complained about this on Ethereum’s research forum & it seems they listened 😃 [return]
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