Computers and Casinos

Interest in blockchain stems from two very different cultures. The first culture sees blockchain as a way to build new networks. I call this culture computer culture because at its core, blockchain drives a new computing movement.

Another culture is primarily interested in speculation and making money. People with this orientation simply view blockchain as a means of creating new transaction tokens. I call this culture casino because at its core it's really just about gambling.

Media reports exacerbated confusion between the two cultures. Stories of making and losing money are always dramatic, easy to understand, and compelling. In contrast, the story of technology is subtle, develops slowly, and requires historical context to be understood.

There is a problem with casino culture. An extreme example is the defunct offshore exchange FTX, and its impact has been devastating. It takes tokens out of context, wraps them in marketing language, and encourages people to speculate. Responsible exchanges provide useful services such as custody, staking, and market liquidity, but reckless exchanges encourage bad behavior and act recklessly with users’ assets. In the worst cases, they are outright Ponzi schemes.

The good news is that the fundamental goals of regulators and blockchain builders are ultimately aligned. Securities laws attempt to eliminate asymmetric information related to publicly traded securities, thereby minimizing market participants' trust in management teams. Blockchain builders also seek to remove the centralization of economic and governance power, thereby reducing the trust that users must place in other network participants.

At the time of writing, the last time the U.S. Securities and Exchange Commission (SEC), the primary regulator of U.S. securities markets, provided substantive guidance on the topic was in 2019. Since then, the agency has brought multiple enforcement actions against trading in a number of tokens it claimed were subject to securities laws, without further clarifying its criteria for making those decisions.

Applying pre-Internet legal precedent to modern networks leaves a gray area while providing significant advantages to bad actors and non-U.S. companies that don’t abide by U.S. rules. Today’s situation is so complex that regulators themselves can’t agree on where to draw the line. For example, the U.S. Securities and Exchange Commission (SEC) says Ethereum’s token is a security, but the main U.S. commodities regulator, the Commodity Futures Trading Commission, says it is a commodity.

Ownership and markets are inseparable

Some policymakers have proposed rules that would actually ban the token, meaning all its practical uses are also banned, even blockchain. If the token is purely for speculation, then these proposals may be justified. However, speculation is only ancillary to the token’s true purpose, which is that the token is a necessary tool for the community to own the network.

Because tokens can be traded like all ownable items, it’s easy to view them as merely financial assets. Properly designed tokens serve specific purposes, including serving as native tokens that incentivize network growth and drive virtual economies. Tokens are not an addendum to a blockchain network, nor are they a nuisance that can be stripped away and discarded, they are necessary and core features. Community and network ownership are impossible without a way for people to take ownership of them.

People sometimes ask whether it is possible to make a token untradeable through legal or technical means, thereby reaping the benefits of blockchain while removing any hint of a casino. But if you remove the ability to buy or sell something, you effectively remove ownership. Even intangible assets, such as copyrights and intellectual property, can be bought and sold at the discretion of their owners. No trade means no ownership, you can't just take one or the other.

An interesting question is whether there is a hybrid approach that could tame casinos while still allowing computers to be built. One proposal would ban token resales after a new blockchain network’s initial launch, either for a fixed period of time or until specified milestones are reached. The tokens can still serve as an incentive to grow the network, but token holders may have to wait a few years, or until the network reaches a certain threshold, before transaction restrictions are lifted.

Time horizons can be a very effective way of aligning people's incentives with wider social interests. Think back to the hype cycles that many technologies have gone through before. Early stages of hype were followed by crashes and then “productivity stagnation.” In contrast, long-term restrictions force token holders to weather the hype and its consequences and realize value by promoting productive growth.

The industry needs further regulation, but it needs to be clear that regulation should focus on achieving policy objectives such as punishing bad actors, protecting consumers, providing stable markets and encouraging responsible innovation. The stakes are high. As I argue in my book Read Write Own, blockchain networks are the only known technology that can recreate an open, democratic internet.

Limited liability companies: a regulatory success story

History shows that smart regulation can accelerate innovation. Until the mid-19th century, the dominant corporate structure was the partnership. In a partnership, all shareholders are partners and bear full responsibility for the actions of the business. If a company suffers financial losses or causes non-financial damage, liability pierces the protective shield of the company and falls on every shareholder. Imagine if shareholders of public companies like IBM and GE were personally responsible for the mistakes the company made, in addition to their financial investment in them. Few people would buy their shares, making it difficult for companies to raise capital. It's more difficult.

Limited liability companies have existed since the early nineteenth century, but were rare. Forming a limited liability company requires special legislative acts. Therefore, partners in almost all business ventures are close partnerships, such as trusted family members or close friends.

This situation changed during the railroad boom of the 1830s and the subsequent period of industrialization. Railways and other heavy industries require large amounts of up-front capital, which is beyond the financial capabilities of small teams and even very wealthy teams can hardly provide alone. New and broader sources of capital are therefore needed to finance the transformation of the world economy.

As you might expect, the upheaval sparked controversy. Lawmakers are under pressure to make limited liability the new corporate standard. Skeptics, meanwhile, argue that expanding limited liability will encourage reckless behavior, effectively shifting risk from shareholders to customers and society at large.

Ultimately, the different viewpoints found a balanced and consistent way forward, with industry and legislators crafting smart compromises that established a legal framework and made limited liability the new normal. This also gave rise to public capital markets for stocks and bonds, and all the wealth and wonder these innovations have produced since then. Therefore, technological innovation drives regulatory changes, which is a manifestation of pragmatism.

How does blockchain move forward?

The history of economic participation is one of gradual and compatible development thanks to the interaction between technological and legal progress. A partnership has a small number of owners, around ten. Limited liability structures greatly expand ownership, and today's public companies even have millions of shareholders. And blockchain networks have once again expanded their scale and scope through mechanisms such as airdrops, grants, and contributor rewards. Future networks may have billions of owners.

Just as businesses in the Industrial Age had new organizational needs, so do businesses in today's Internet Age. Imposing old legal structures (such as corporations and limited liability companies, etc.) onto new network structures, this mismatch is the root cause of many problems in enterprise networks. For example, they have to start from very attractive models. Inevitably switching to extractive mode and excluding large numbers of contributors from the network. The world needs new, digitally native ways for people to coordinate, collaborate, collaborate and compete.

Blockchain provides a rational organizational structure for the network, and tokens are a natural asset class. Policymakers and industry leaders can work together to find the right guardrails for blockchain networks, just as their pioneers did for LLCs. These rules should allow and encourage decentralization rather than default to centralization as is the case with corporate entities. There are many things that can be done to control casino culture while encouraging the growth of computer culture. Hopefully smart regulators will encourage innovation and let founders do what they do best: build the future.

This excerpt comes from Chris Dixon, author of "Read Write Own: Building the Next Era of the Internet", and was first published on the Fortune website on March 10, 2024 .