Author: smogbar

Who determines a blockchain’s DNA? Who has the right to make decisions, and how is this right implemented in reality? More specifically, what is a blockchain’s system of governance, or “who guards the guards?”

Can blockchain technology enhance agricultural supply chains for small business farmers? A look at the issues, opportunities, and projects working to ensure the future of agricultural supply chains and small-scale farmers.

Don’t worry about the bear market. As an emerging technology, blockchain is on a typical journey to maturity and mainstream adoption.

Security Token Offerings (STOs) are the latest hype in the crypto community. Go to any conference and I guarantee you’ll hear one of the following statements.

Really?

I’m calling BS on all of it. Well, most of it, for now, anyway.

To be clear, I’m not anti STOs. I understand they could one day open up new untapped investment pools, bring more liquidity to the economy, make capital raising easier, faster and cheaper, and provide retail investors access to a new investment class.

That’s all great stuff, but people in the crypto community are running around acting like STOs are a workable, feasible and practical option today. Nothing could be further from the truth.

Hidden in plain sight are major structural challenges which put the viability of STOs and the benefits they are said to provide into serious question. Get ready because in 2019 this delusional STO hype is going to be met by a cold, hard, and highly regulated reality.

What is a Security Token Offering (STO)?

Let’s get on the same page about what we’re referring to here. A Security Token Offering (STO) is a regulated public securities offering of equity in a private company. When conducting an STO, a company issues equity tokens to investors which are legally binding investment contracts that represent the ownership of equity in a company, dividends, voting rights and more.

Rights are programmed into token smart contracts which are designed to enable the automated execution of these rights. This differs from an ICO utility token offering where contributors do not acquire any rights or equity in a company, rather future access to a product or service.

STOs do not beget liquidity

There are many people who seem to think that STOs result in the spontaneous, magic- like emergence of liquidity. In private markets, especially with small and micro-cap issuers, liquidity is very difficult to create. Not only will issuers have a tough time attracting investors but investors will also find their tokens have almost ZERO liquidity.

There are no secondary markets

No secondary markets exist to buy and sell security tokens, and this might not change for some time to come. Well, that’s not exactly true. There is a handful, but they have little to no volume which defeats the purpose of having them in the first place.

The reason for the lack of exchanges is that in most jurisdictions obtaining a license is difficult and compliance is a costly nightmare. Exchanges must adhere to rigorous and continual checks, reporting, KYC and much more. Meeting all the requirements is just too complicated, costly and risky especially when taking into account that several licenses may need to be obtained and different regulation sets adhered to in each and every jurisdiction of operations (national and international).

Traditional stock exchanges like NYSE or NASDAQ are not yet offering securities tokens because they lack the infrastructure for blockchain based digital assets. What’s more, in the US, these traditional exchanges are the only exchanges that enjoy a pre-emption of state blue sky laws. For the reasons listed above it would only make sense to set up a security token exchange on a national exchange or maybe an ATS that offers this benefit otherwise registration is required in each of the 50 states.

Adding to these complexities is the fact that other regulation sets may also apply in addition to securities regulations. For example, an exchange contemplating using security tokens denominated in cryptocurrency must abide by a whole different set of rules which apply to the transfer of cryptocurrency. In New York, this would be a Bitlicense.

With only a few exchanges that feature little to no trading volume, why would any investor want to purchase security tokens? For the possibility that maybe sometime in the future a market will exist with sufficient trading and demand?

There are no liquidity providers

Even if exchanges existed to trade security tokens that wouldn’t be enough to create adequate levels of liquidity. The creation of true liquidity also requires an infrastructure of liquidity providers. This is different to exchanges which can be thought of as trade facilitation platforms. Liquidity providers are the researchers, analysts, and salespeople who call customers to create buy orders to offset sell orders at the point in time they are required. They can be thought of as liquidity matchmakers.

“Tokenizing securities is not a magic recipe for liquidity. Tokens can be equally illiquid as their legacy digital or paper certificates. Tokens do not beget liquidity. Technology does not generate liquidity. Buyers and sellers create liquidity.” – Matthew Finestone

What’s important to understand here is that creating liquidity is a people-intensive endeavor. Doing an STO doesn’t nullify this fact which means that without liquidity providers equity tokens are highly illiquid.

Investor demand is probably overblown

One of the major selling points of an STO is that it enables global access to the holy grail of investors – the unaccredited retail investor. While this isn’t currently true, let’s pretend it is. Is there really a demand for security tokens on main street?

Let’s remember that there is a market today where retail investors can invest in their favorite companies like Apple, Facebook, and Nike quite easily, yet most people don’t. If most people don’t even buy stock in the brands they know and trust, what would have us believe they will buy stock in a small private company they have never heard of?

STOs don’t offer easy access to a global pool of investors

If a project registers and adheres to securities regulations in one jurisdiction it doesn’t mean they can offer their security tokens anywhere in the world or even country-wide. It certainly doesn’t mean that retail investors can be sold to either.

An STO can only be registered and sold in jurisdictions that allow the crowdfunding of equity; otherwise, it’s illegal to do so. When dealing with a security, a company cannot even begin to transact until they have the regulatory licenses and provisions in place in each jurisdiction they wish to operate or qualify for an exemption.

Herein lies the problem. Regulations differ substantially from country to country making for nightmarish and costly regulatory upheavals. For example, most jurisdictions have tough restrictions on who can purchase securities. Tough and divergent regulations make it really difficult and costly to tap into a global pool of accredited investors and, for the most part, put retail investors entirely off-limits.

A US-based example & fragmentation in Asia

If you’re a US-based company and abide by Reg S, a US securities law that allows companies to raise funds in foreign jurisdictions without breaking any US securities laws, there is nothing in this regulation that says anything about foreign securities laws in overseas jurisdictions.

So, yes, while it’s possible to offer tokens in foreign jurisdictions, US-based projects will still need to understand and abide by local securities laws. There is a considerable risk that local laws will be violated by incorrectly assuming Reg S enables securities to be sold to any investors in overseas jurisdictions carte blanche.

There are also grey areas as to what it means to be outside US jurisdiction anyway. Even if you fall outside a jurisdiction, regulations in the US can be interpreted in different ways. For example, having an offshore issuer may not alone mean a project is outside the US for securities law purposes. In a recent case, a court looked at where the validation nodes were located among other things.

In Asia, regulations around STOs are fragmented and dependent on what country you operate in. Like in the US, there are no specific regulatory exemptions tailored to STOs so companies must go through existing securities frameworks or work within exemptions. In Hong Kong, institutional investors can invest in STOs that are registered and compliant with regulations. In Singapore, a strict securities regulatory framework exists supervised by the Monetary Authority of Singapore (MAS) which has its own set of rules and exemptions while in China STO activities are illegal.

It’s a regulatory jungle out there

Claims that STOs offer easy access to a global pool of accredited investors is not true. In fact, the reality may well prove to be the exact opposite for small and mid-sized companies because complying with each jurisdiction will prove way too costly and complex. These costs and complexities lead to risks that startups and even mid-sized companies cannot handle and frankly make the entire STO endeavor not worth it. There is no access to a global pool of retail investors either because regulations in many jurisdictions explicitly prohibit this.

Nobody knows what the future holds but there is no sign of anything close to a global convergence of securities regulations. We’re in the early days, so regulators will be evolving and playing catch up for many years to come.

STOs don’t make fundraising easier and cheaper

Beyond compliance which requires an extensive amount of investor protections, financial reporting, KYC, AML procedures, and other tasks, there are several stakeholders that security token issuers will have to work with such as bankers, lawyers, accountants, exchanges, and custodians (read money sucking intermediaries). These intermediaries do things like underwrite deals and solicit investor interest in a compliant manner.

Companies with minimal funds, experience, and know-how will find it almost impossible to conduct a compliant STO on any sort of scale because the more jurisdictions an STO is offered, the more intermediaries, regulatory complexities, and costs increase.

If this were not enough, there is a lot of regulatory greyness which increases the risks of doing an STO as well. Here’s just one example. Because the tokens offered are regulated securities, does that mean every time it moves on a blockchain it counts as a securities transaction? If this is true, do blockchains need to be registered as some sort of trading venue to facilitate all the securities transactions?

There is also the business side to consider. Who’s going to attract the investors to this new form of investment? What’s the value proposition? STOs are no different from any other method of raising capital in this regard. Companies will have to solicit within the laws and have marketing spend to attract investors in traditional ways. They will have to push a hard sell because most investors will only come when there is true liquidity which doesn’t exist at this time.

Regulatory exemptions don’t necessarily ease the pain 

Companies conducting an STO will no doubt target an exemption to ease their regulatory burdens. Exemptions do offer benefits, but they come with challenges as well. For example, in the US, tokens can be issued under Reg D, Reg A+ or CF. Reg CF caps the amount that can be raised and the amounts each investor can contribute. Reg A brings higher disclosure burdens, and a stricter qualification process and Rule 506 of Regulation D has an accreditation threshold.

Many exemptions also have a lock-up period for up to 12 months which can cause significant challenges for investor liquidity and thus the attractiveness of the investment in the first place. Offering the tokens in multiple jurisdictions also requires qualifying for multiple exemptions which require a deep understanding and the correct navigation of foreign regulation sets.

The point is, offering security tokens come with a whole lot of follow on implications and challenges, whether a project qualifies for an exemption or not.

Technology stacks might be incompatible with regulations

Thus far, for the most part, the majority of teams in the tokenized securities industry are building on top of the Ethereum blockchain as it is the most well known smart contract platform with decent levels of functionality. They are adding layer 2 solutions with different privacy features.

This approach may backfire because these solutions need to work around the limitations of the base protocol which are already built with some kind of concept in mind. Ethereum is an open and transparent ledger which is a problem as confidentiality is often a significant requirement for regulators as well as businesses. The blockchain infrastructure used by a project must adhere to confidentiality and accountability requirements set out in securities regulations to have any chance at offering a compliant STO.

If one of the main goals of putting securities on a blockchain is to take out the intermediaries in the heavily regulated securities market without losing regulatory approval, can this be done with current platforms like Ethereum? Do newer security token platforms understand the regulations? What if they break securities laws, who gets the blame?

Some projects are working on unique blockchain infrastructures to launch regulation-compliant tokens but which regulations will they base their platform on? How will they enable global STO offerings which must comply with different securities laws? How can a blockchain platform adhere to divergent securities regulations and what happens if/when these rules change?

There are also issues about how to regulate and verify a systems-based response to the acquirement of an asset. This is not just about immediate and once off verification. It’s about ongoing compliance and showing this compliance. How will this be built into a blockchain? How will intermediaries and regulators interact with these systems?

With regards to smart contracts, regulators are going to want to know what kind of testing has been done and is this testing being done on an ongoing basis? These are just two of the most straightforward questions surrounding the application of the technology. And what about the question alluded to previously. If a token is a security, does that mean every time it moves on a blockchain it counts as a securities transaction? If this is true, do blockchains need to be registered as some sort of trading venue to facilitate all the securities transactions?

There are simply too many unanswered questions that will take time to resolve. However, it would be reasonable to conclude that projects will need to have the technology stack that facilitates their STO approved by regulators prior to an STO launch. Taking all of these complexities into consideration, do we really think 2019 will be the year of the compliant STO?

A cold, hard, and highly regulated reality awaits

Many proponents of the security token offering fail to consider a seemingly obvious fact. STOs do not exist in a vacuum. Instead, they must fit in with a highly regulated financial world built up over decades. A world that features lots of moving parts, legacy systems, intermediaries and powerful incumbents with vested interests all of which have been designed around these established sets of regulations.

It is precisely these realities, the infrastructure of entangled, technologies, regulations and supporting human elements that make changes, especially significant changes, so hard to realize. And it leads me to my sobering outlook on the viability of STOs in the near term.

“We always overestimate what we can accomplish in one year and underestimate what can be accomplished in 10 years.”

Of course, the existence of these regulatory and technological challenges won’t stop the STO hype train from ratcheting up another gear or prevent investment from flowing in. The crypto community loves a good dose of hype and will no doubt continue to underestimate the cold, hard, regulated reality that awaits.

Did you enjoy the article? Please take a quick moment to share it with your network. Also, if you have any questions or would like to connect you can find me on Twitter or email me at [email protected]  I’m always interested in meeting people working, learning, or involved with the blockchain space.

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Also published on Medium.

I’m always interested in meeting blockchain startups or talking to Developers who are creating innovative products, so please feel free to contact me on LinkedIn, or by email at [email protected]

Collin Thompson is the Co-founder, and Managing Director of Intrepid Ventures, a blockchain startup and innovation studio that invests, builds and accelerates Blockchain companies solving the world’s most difficult problems. Collin focuses on early-stage investments, innovation and business design for corporations, governments, and entrepreneurs working with blockchain technology.

Also published on Medium.

After many years of crisis, scandals, low growth rates and declining customer satisfaction, there are compelling reasons for the radical transformation of insurance services to occur. There are also powerful arguments as to why these transformations will need to begin in the emerging economies of Asia.

The case for change

For industry, nations, and consumers the transformation of insurance is more critical today than ever before.

For industry

Limited growth in mature markets and pressures to reduce costs are taking a toll on the insurance industry.

Armed with outdated IT infrastructures, insurance providers have little capacity to reduce spiraling administrative costs or develop cost-effective services for low-income developing markets. Companies remain helpless to increase their customer base or meet internal growth targets.

Restrictive IT infrastructures have led to poor customer engagement and ineffective fraud detection methods and pricing structures as well.

“So far the industry has been perceived to be fairly reactive to technology, to have issues with IT prioritisation and implementation, and ultimately to be relatively slow to innovate and change.”[1]

The time has arrived to overhaul the legacy IT systems that continue to cause significant inefficiencies and increased risks.

Seeking out transformational technologies that reduce inefficiencies and enable the delivery of innovative products and services to untapped developing markets around the world is now critical to future competitiveness.

Forget “first the west, then the rest”, it’s about “the rest, then the west”…

It’s important for companies to understand that technology adoption is no longer the exclusive domain of consumers in the West. Technology adoption today often begins in emerging economies and then flows to the west.

Out of the world’s developing economies, the emerging economies of Asia represent an unprecedented opportunity to experiment with low-cost innovation and open regulatory frameworks.

They also represent a vast customer base hungry for new services. Companies that are able to deliver micro-insurance services have the opportunity to tap into these vast markets.

A “first the rest, then the west” approach is now an imperative for future innovation, growth, and success.

For nations

For the hundreds of millions of low-income residents in the emerging economies of Asia, from Indonesia and the Philippines to Cambodia and Vietnam, access to formal financial services, especially insurance, remains extremely low.

Without the ready availability of insurance products and services to all segments of society, the economic progress made by individuals in these and other nations will remain tenuous, and future economic development will be limited.

Insurance plays a key enabling role in wealth creation, and economic growth as coverage is a prerequisite for financial institutions to offer many other types of financial services.

Governments must, therefore, begin to lay the regulatory foundations for the future proliferation of micro insurance services if they are to realize their nation’s financial inclusion targets and overall potential in the new innovation-based economy.

For Consumers

In most of the emerging economies of Asia, insurance coverage remains rare.

In fact, according to the Asian Development Bank, insurance penetration in Indonesia, Cambodia, and Myanmar is almost non-existent.

In the Philippines, insurance penetration is estimated to be around 4%, relatively high when compared to Indonesia where 1% of insurance needs are currently met.[2]

There is now widespread recognition from those in the development sector that insurance is a vital financial service to help people climb out of poverty, manage various risks and protect valuable assets.[3]

The continued absence of viable products and services means that the livelihoods of millions of individuals continue to remain uncertain.

“Insurance can protect the poor against losing their livelihoods and assets due to natural disasters or sudden illness thus preventing them from falling back into cyclical poverty.” [4]

For the small minority of these populations lucky enough to have access to insurance services, low levels of transparency, fairness in charges and claims handling and a severe lack of consumer protection is a significant problem.

Individuals with limited education and familiarity with complex insurance products remain at risk of exploitation unless insurance providers can simplify their offerings and realign their incentives.

Several problems, one corrosive root cause

Over the last decade, a dramatic shift in trade power has taken place away from the advanced economies in North America and Europe to the emerging markets of Asia. [5]

From nations like China that have developed at a rapid pace to countries that are at the beginning of their economic development journey like Myanmar, the emerging economies of Asia are now a vital part of the world economy.

But offering services to these low-income markets in Asia has remained entirely out of reach for most insurance companies. This despite the massive growth opportunities and a general awareness of the importance of these markets among industry executives.

Why?

The answer is surprisingly simple and can be traced to a single, yet highly corrosive root cause.

Fragmented, old-world IT systems and siloed record keeping infrastructures that lack basic levels of interoperability.

It is the outdated systems utilized by most insurance providers that are creating the spiraling costs and crippling inefficiencies which have in turn prevented insurance companies from developing cost-effective micro-insurance services for low-income customers in the emerging economies of Asia.

Simply put, without the transformation of these systems, insurance companies will become increasingly inefficient and remain unable to access vital growth opportunities.

A devastating flow on effect

Sky high administrative costs & backend inefficiencies

Administrative expenses and backend inefficiencies are crippling the insurance industry. With complex contracts between multiple stakeholders that need a significant amount of human processing, the administration of insurance has not only become expensive but highly inefficient as well.

Underwriting and claims settlement, two critical processes conducted by all insurance companies today involves the time-consuming and often inaccurate evaluation of information.

After a claim is registered, an astonishing variety of tasks must be completed. These include but are not limited to, the retrieval of supporting documentation, performing fraud detection checks, determining which party is liable for the damage, determining the amount of the claim, and communicating back and forth with the customer and other parties involved.

Processes are slow, manual, paper-based, repetitive, expensive and also prone to errors and duplication.

Inefficient client onboarding and compliance processes

Insurance companies must complete several compliance related steps which create significant time and cost delays as part of the onboarding process for new clients.[6] These include the collection, validation, and verification of key documents such as proof of identity, proof of address and proof of birth.[7]

Compliance officers must also manually check and share enormous amounts of data with third parties and internal due diligence teams which can take a considerable amount of time to complete. [8]

Vast resources are spent by companies to fix needless errors during the compliance process and reconciling data sets across departments and external intermediaries is a massive headache.

Ineffective fraud detection

It is estimated that $45 billion is lost annually to insurance fraud with approximately 65% of fraudulent claims going undetected.[9]

Fragmented and siloed record keeping practices together with record systems that lack basic levels of interoperability have led to a severe lack of advanced data available for risk analysis for fraud detection.

Legacy systems prevent risk and compliance teams from gaining a systemic view of transactions and a complete historical record of a customer, limiting their ability to identify duplicate transactions or those involving suspicious parties.[10]

With a limited ability to detect fraudulent activities, insurance companies must deal with greater risks and expenses and charge higher premiums to their customers.

Blockchain replaces fragmented and siloed record keeping infrastructures with a unified platform

If you’re like many insurance executives, you may be wondering what all the blockchain fuss is about. The technology continues to garner endless attention yet there remains a lack of understanding among decision makers within the industry.

Putting the hype and bluster aside, the promise of blockchain lies in its capacity to eliminate the root cause of the inefficiencies that impact the delivery and management of insurance services.

“This technology has the potential to impact the entire insurance value chain end-to-end, including information collection, underwriting, rating, actuarial analysis, quoting, binding, billing, contract management, claims processing, distribution, policy administration and also regulation.”[11]

Blockchain technology offers to rid the insurance industry of the high administrative costs and backend efficiencies that have plagued the insurance value chain.

Labour-intensive, repetitive and error-prone underwriting and claims settlement processes are transformed through the use of a unified platform to store and share all documentation.

“Every personal insurer’s core computer system is, at heart, a big, centralised transaction ledger. At the very least, blockchains deserve to be evaluated technologically by insurers, as a potential replacement for today’s central database model.”[18]

There are significant benefits for compliance as well. Regulators can gain access to full sets of unchangeable data in real time without requiring companies to conduct reconciliation and the collection of detailed information for reports.[12]

With the same data available to all parties, insurance platforms powered by blockchain can experience unprecedented data sharing capabilities and back-end analytics for pricing and risk.[13]

“We believe that blockchain will play a major and disruptive role right across the insurance value chain. From customer onboarding and ‘Know Your Customer’ (KYC) requirements through to claims processing and adjudication, the potential use cases for blockchain in the insurance sector grow each day.”[14]

Detailed audit trails of all past insurance claims can be maintained for risk analysis and fraud detection. Risk teams gain a system-wide view of all their customer’s records to enable not only the identification of duplicate transactions but also those involving suspicious parties.

As a result, long and tedious onboarding and verification processes experienced by legitimate customers can be dramatically reduced.

Smart contracts could change the game

Equally as fundamental to the future of insurance are smart contracts. When run on a blockchain, smart contracts become self-executing contracts where contractual enforcement, rights, obligations, performance, and payment are automatically executed.

By enforcing the rules for insurance claims through code instead of human decision making, event-triggered smart contracts make it possible to automate some types of claims.[15]

“Alongside big data, mobile and digital technologies, blockchain is essential to establishing an efficient, transparent and customer-focused claims model based on higher degrees of trust. Within claims prevention, new data streams can enhance the risk selection process by combining location, external risk and analytics. A distributed ledger can enable the insurer and various third parties to easily and instantly access and update relevant information (e.g., claim forms, evidence, police reports and third-party review reports).”[16]

InsurETH, for example, a company developing blockchain solutions for the insurance industry, built a flight insurance product that runs smart contracts on the Ethereum platform to automate insurance claims and automatically refund users in case of flight delays or cancellations.

By eliminating the manual processes involved in claims management, smart contracts can reduce the costs and time associated with the handling of claims and also disintermediate the claims process.

The use of data from a mobile phone or sensors could streamline claims submission as well.

A report from EY explains,

“The use of data from a mobile phone or sensors can streamline claims submission, reduce loss adjuster costs and increase customer satisfaction, with blockchain systems facilitating communications and coordination among all parties. Consider how sensors can trigger alerts to insurers that a crash has occurred (thereby initiating a new claim), and then route secure and relevant data to preapproved and conveniently located medical teams, towing services and/or repair garages.”[17]

By making the processes associated with the delivery and management of insurance services more accurate, efficient and secure, companies can save money on their service offerings in mature markets and also gain the capacity to offer cost-effective micro-insurance services to low-income markets in the emerging economies of Asia.

The future of insurance starts today in the emerging economies of Asia

The insurance sector has traditionally been slower than most other industries to adapt to change. Decades of neglect driven by conservative and risk-averse cultures have brought the industry to a tipping point.

Outdated systems and IT infrastructures have left insurance companies with gross inefficiencies, high administrative costs and ineffective fraud detection methods.

Insurance companies are failing their current customers and continue to have a limited capacity to develop cost-effective products and services for underserved low-income markets.

With limited growth in mature markets there are now acute pressures to innovate and find new sources of growth.

Insurance executives must come to the realization that band-aid solutions cannot fix the root problems afflicting the industry or meet the challenges of tomorrow.

There is also a need to internalize new realities that have come with globalization and the new digitally based world economy. Economic power shifts in recent years away from the West to the emerging economies of Asia mean that significant growth is no longer found in New York, London or Paris.

Ho Chi Minh skyline – a symbol of economic growth and increasing prosperity in Vietnam.

Rather it is the economies of China, Vietnam, Indonesia, the Philippines and many others that hold unprecedented growth opportunities.

For hundreds of millions of low-income people living in these markets, access to formal financial services, especially insurance has will mean the continuation of real economic growth and formal inclusion into the global economy.

Nations and industry have important roles to play to ensure both financial inclusion and competitiveness.

Governments must lead by example and begin to lay the regulatory foundations for the future proliferation of insurance services. They must also initiate collaboration with the insurance industry to seek out and test new technologies for mutual benefit.

“Like the first generation of the internet, this second generation promises to disrupt business models and transform industries. Blockchain (also called distributed ledger), the technology enabling cryptocurrencies like bitcoin and Ethereum, is pulling us into a new era of openness, decentralization and global inclusion.”[19]

Industry will need overhaul legacy systems and embrace transformational technologies like blockchain that can enable the delivery of cost-efficient micro-insurance services to new developing markets to ensure competitiveness.

A supercharged insurance industry powered by blockchain technology in combination with a modernized regulatory framework will not only lead to critical growth opportunities for companies but also help trigger the proliferation of financial services and drive economic development in the emerging economies of Asia.

Discover how blockchain technology could transform, global supply chains and national healthcare systems.

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Realizing the revolutionary nature of blockchain technology and the existence of a significant knowledge gap among entrepreneurs, industry, and government, Anthony now concentrates his time on creating educational content, researching potential use cases and analyzing the impact of the technology on global industries.

Also published on Medium.

Note: This post should not be considered professional investment advice. If you want to invest in digital assets like cryptocurrency, assess your own personal and financial situation, risk tolerance and consult a financial professional.

Cryptocurrencies have become a significant topic of interest for investors. As with any overly hyped topic, there are polarising opinions and lots of noise, making it difficult for investors to get a clear picture of the risks involved. The truth is, cryptocurrencies are in their infancy and have several significant risks that demand an investor’s attention. Over time, these risks will increase and decrease, and new risks will emerge. If you’re considering whether to add cryptocurrency to your traditional portfolio, here are a few critical risks to examine.

Price volatility & manipulation

Cryptocurrencies have been on a wild ride. Epic booms, busts, wild swings, and scams have amazed and baffled investors who have witnessed unexplainable and unprecedented gains and losses over the last decade.

For example, here’s a coinmetrics chart on the volatility of daily returns (14-day average) comparing BTC (Red) to S&P 500 (Teal). Volatility swings in Bitcoin (BTC) and other crypto assets makes it hard for investors (especially retail investors) to build confidence and secure gains.

Volatility in crypto prices is common and generally stems from three main sources; sentiment, speculation and market manipulation. It’s the unregulated and anonymous nature of digital asset markets combined with the susceptibility of cryptocurrencies and other crypto assets to sentiment, emotion, and publicity that make prices volatile.

Crypto exchanges, media owners, and powerful investors can manipulate prices. This manipulation seems to be widespread – albeit not widely proven yet. The most used manipulation strategies include wash trading, dark pool trading, pump and dumps, and shilling.

Lack of regulations

A lack of regulatory frameworks means there is a high degree of uncertainty like price volatility and manipulation. Investors and entrepreneurs are also concerned about the possibility of future restrictions which may have a significant impact on the value of cryptocurrencies or completely ban them altogether.

For the large part, crypto regulations are complex, disorganised and haphazard. One area of particular concern for investors is tax treatment. A lack of regulation or what some term as regulatory greyness means some investors are scared off investing because they don’t have a clear understanding of what tax obligations need consideration or what actions must be taken and what records need to be kept.

The good news is that regulators are catching up. Authorities in many jurisdictions are taking steps, producing research papers, standards and introducing new regulations. One of the first countries to begin building a robust regulatory framework is Switzerland. The country has proposed an idea for minimising rules while still keeping companies in line with legislation through ‘sandboxes’ allowing startups to experiment and innovate within controlled conditions. Britain and Singapore have been exploring their blockchain and crypto regulatory environment as well, providing platforms which enable companies to experiment under relaxed regulation and licensing requirements. In the US, the New York Attorney General’s Office recently launched the most comprehensive study on exchanges.

Market adoption

Thanks to a market downturn, the entire digital asset market is worth less than McDonald’s. But even before the 2018 slump, the crypto market relative to other markets like currency, gold, stock markets was vastly smaller.

Market adoption remains low for a host of reasons from regulatory concerns and technology shortfalls to market volatility, public misunderstandings and the fact that cryptocurrencies and the underlying blockchain technology that powers them are still emerging and in their infancy. This means there’s a chance that this new asset class, impeded by many different factors, regulations being one of them, will never be broadly adopted, leading to a complete loss of value. There is a clear need for more regulations, technology improvements and institutionalisation to help drive trust and scale.

Security, custody & consumer rights

Storing cryptocurrencies and other crypto assets can be risky business. There have been significant incidents of theft on personal wallets but also on exchanges. Hacking remains a constant threat if cryptocurrencies are not correctly stored and protected. To make things worse, assets that get lost or stolen cannot be recovered, and mistaken transactions cannot be reversed. Also, unlike traditional investing through a bank or brokerage, cryptos don’t have official safeguards or insurances. Rebates on lost investments depend on the whim of the organisation you’re dealing with.

The good news. Custody solutions which give financial institutions the ability to hold cryptocurrencies on behalf of trading clients are beginning to emerge. This is expected to catalyse the entry of institutional capital into the industry and in-turn provide a trusted stamp of approval for retail investors as well.

Coinbase has announced its custody product upon completion of their first successful deposit. The multinational investment bank, Citigroup, has announced that it will offer crypto custody solutions to institutional investors. Citigroup launched a product called Digital Asset Receipt, intended for institutional investors to securely invest in cryptocurrencies in a regulated and secure manner. There is also Fidelity, which has announced a new and separate company called Fidelity Digital Asset Services. The Wall Street incumbent will handle custody for major cryptocurrencies such as bitcoin and execute trades for investors such as hedge funds and family offices.

Exiting the market

The crypto market’s off-ramps are a real problem for many investors. Many exchanges only allow withdrawals in USD, some also allow EUR, GBP, and JPY, but the choice is minimal, and exchanges frequently require high minimum withdrawals when withdrawing to fiat. Lots of exchanges that support fiat withdrawals also only accept a few leading cryptocurrencies and to withdraw fiat money, investors need to go through a tedious verification process that can take months.

Some exchanges have also been accused of withholding funds for unclear reasons, and many banks are still very wary of accepting money from the sale of cryptocurrency. All this exposes investors to exchange rates, fees, and risks associated with dealing with opaque exchanges. The situation is improving, but it’s far from ideal.

Did you enjoy the article? Please take a quick moment to share it with your network. Also, if you have any questions or would like to connect you can find me on Twitter or email me at [email protected] I’m always interested in meeting people working, learning, or involved with the blockchain space.

Anthony is the head of content and research at Intrepid Ventures. 

Also published on Medium.

This article on ICO law is part of our “How to Launch an Initial Coin Offering” comprehensive guide. If you are interested in understanding all the necessary aspects involved in launching an ICO and are looking for a deeper ICO checklist we recommend you download our guide here.

The fast pace with which the blockchain space has moved has made it very difficult for legislators to keep regulations relevant and up to date.

The absence of ICO-related regulations, however, does not mean that blockchain startups and their ICOs are exempt from the law. It is quite the opposite. Teams that decide to run an ICO should be extra careful and determined to be compliant to avoid inadvertently committing any offenses.

Below you can find a series of aspects you need to understand before you launch your project or ICO. This will require seeking advice and counseling from professionals who can help you better define some of these matters.

Corporate formation

One of the legal matters that must be navigated relates to what kind of structure will be chosen for the project. If you have not decided on the structure of your business, you might fall into a default general partnership, where all founders would be operating under full personal responsibility for all actions performed during the business.

One of the most common practices when doing an ICO is to separate the operating entity from the token issuer company. This is done for several reasons including separating legal liability and also choosing different business entity types according to the function of each entity. For example, foundations and trusts are commonly used entities to run ICOs but are not the best option to operate a business.

One advantage of such a separated structure is that the two entities may be located in different jurisdictions. Your operating entity could be located in almost any jurisdiction without any risk as long as you abide by the current legislation. On the other hand, for your token issuer company, you might want to choose the jurisdiction with more friendly or flexible legislation. You can find more about these in the next sections.

NOTE: When running an ICO what typically matters is where the investors are located and not where the issuing entity is. You should consider this when you decide what investors you will whitelist for your sale.

How to choose the right jurisdiction

Even though legislation continues to lag behind the industry, many national authorities have begun to issue guidelines for ICO investors. While these guidelines are not 100% ideal, they should be seen optimistically, as progress of a kind. It is essential to understand that they are being developed with investor protection in mind, and with a desire to make the space more transparent.

That said, regulations and guidelines vary significantly between jurisdictions. They depend on several factors such as how authorities perceive cryptocurrencies, securities laws, consumer and investor protection laws, AML regulatory frameworks, and on the jurisdiction’s willingness to promote blockchain innovation.

Many jurisdictions are trying to attract progressive entrepreneurs to their territory and are quite open to helping you succeed. Below you can find some elements to look for when deciding on a jurisdiction:

– Cooperation with industry

Some jurisdiction’s frameworks may seem very flexible and work well for traditional industries, but this might not be the case for new and disruptive projects that involve cryptocurrencies.

Look for an emphasis on stimulating innovation, entrepreneurship, and small business growth. Having an open policy and cooperative approach will make a significant difference when it comes to opening bank accounts and getting ancillary business and corporate services.

– Access to legal and industry representatives

Any cooperation to help with setting up an entity or open an account will be to little or no avail if you have no access to legal and industry representatives. Running an ICO will demand a lot of direct interaction with authorities on a regular basis. The jurisdiction you select should provide direct access to an informed representative that you can easily contact to retrieve a quick response.

– Consumer and investor protection

Investors and consumers will feel more secure with their investment in your project if they see you have a regulatory stamp of approval from a jurisdiction that protects their interests. It gives them certainty that you are operating above board and provides a place they can go to argue any grievances should something go wrong.

In general, a regulator’s quality can be primarily determined by how well it protects consumers and investors and how easily accessible they are in the event of a dispute.

– Clear definition of cryptocurrency

A clear definition shows that the jurisdiction is already aware or involved in the industry and probably moving forward with more structured and definitive legislation. A definition may also signal how welcoming a jurisdiction is of “coins” and/or “tokens.” Be sure to read and analyze the definition for these in the jurisdiction you choose.

– Industry Advocacy Group(s)

Any jurisdiction which has an active industry advocacy group working to develop regulations and an amicable environment for blockchain projects should earn a lot of points on your list.

A strong and active advocacy group not only shows that a jurisdiction is robust, but it also provides you with allies and a group with whom to work with on the policies of your company.

– Kinds of corporate formations

Structuring a distributed and international small business is not easy. Making sure that the jurisdiction has the proper legal vehicles for your project is critical. Like we mentioned above, the trend in the blockchain and cryptocurrency industry is to have a foundation as the main vehicle to accept tokens and govern your ecosystem, but this does not mean it is the best, nor the only one.

Make sure to design your business structure with experts in the field to know what your needs will be. Some of the leading jurisdictions for blockchain projects and ICOs are:
– Switzerland – Singapore – Hong Kong – British Virgin Islands – Cayman Islands

– Isle of Man

(As the industry develops these may change a lot with some of these being less friendly and new jurisdictions coming up. Estonia, Belarus, and Slovenia are moving fast to become crypto-friendly countries for example.)

Remember. Even though these jurisdictions are leading the way in many respects, each one will have their benefits and drawbacks. When it comes to choosing a jurisdiction for your ICO, it’s vital to examine what your specific needs are and what you are willing to trade off.

Securities & commodities laws

Despite a large number of legal aspects to consider, the most significant concern for most projects is whether their token falls under the category of securities.

This topic gained particular notoriety when the SEC released an investigative report concluding DAO Tokens were securities, and because so much speculation and uncertainty exists right now, anxiety levels are very high. Nobody wants the SEC calling on your phone.

Most jurisdictions have yet to take a clear stance on whether tokens or which tokens, if any, will be considered securities. In other words, just because authorities haven’t come out yet and said that some specific tokens would be regarded as securities doesn’t mean it will stay this way in the future.

Non-US investors are not subject to US Securities laws, so some ICOs target only non-US investors. But this does not mean they are completely covered as it’s very easy to mask your location on the Internet and not all identity verifications (especially on exchanges) are exhaustive.

One of the most common ways of figuring out if your ICO might be considered a security offering is to run it through the US Supreme Court Howey Test. However, be wary of interpreting these results as definitive. Regulators use several other methods to define your token and even all of this cannot give you a definitive answer.

There are currently several organizations working in the blockchain space to clarify these uncertainties. One such organization is Coin Center – a nonprofit focused on policy issues facing cryptocurrencies. Coin Center has published a Framework for Securities Regulation of Cryptocurrencies and a more specific Securities Law Framework for Blockchain Tokens.

– AML and KYC laws

In almost every legal jurisdiction, no matter what the legal definition of cryptocurrency is, you will almost always be required to abide the financial surveillance laws.

These are better known as the Know Your Customer (KYC) and Anti-Money Laundering (AML) rules. In simplest terms, these are laws that mandate that “financial institutions” (a broad category of businesses offering financial services) must collect and retain information about their customers and share that information with the appropriate regulatory entities.

Regulated entities are traditionally required to collect a government-issued ID + a utility bill for a person, in this case, your customers. However, this may vary according to the jurisdiction you are operating under, and if your entity is considered non-regulated, these requirements could be less.

Your KYC related activities depend on how your token is defined. If it falls under the security category, KYC regulations must be fully adhered to (not to mention many other considerations like making sure purchasers are accredited investors). On the other hand, if your token is considered a utility, legislation tends to be more flexible.

– Crowdfunding laws

Although the concept of ICOs and crowdfunding through tokens is revolutionary, not every aspect of it is entirely new. Some of the problems have been dealt with before.

In mid-2016, the US implemented Title III of the JOBS Act, which legalized equity crowdfunding for non-accredited investors. At its core, it is very similar to what ICOs have come to deliver on: democratize the funding process and allow the raising of funds from a crowd or community and not just a small elite of venture capitalists. Analyzing the crowdfunding laws in the jurisdiction in which you hope to launch is an option.

– Taxation

Specific taxation frameworks on ICOs are still not entirely defined. In addition to this lack of regulation, the fluctuation of cryptocurrencies presents another challenge as to how to run your business.

It’s wise to choose a jurisdiction which provides a favorable tax policy to minimize future headaches. Each jurisdiction, based on their categorization of a cryptocurrency will require you to report tax on either; sales tax, VAT, capital gains, or all of them.

Particularly if you are not running a foundation, a low tax jurisdiction, with a clear categorization of what a cryptocurrency is and how it is taxed, will help the management and accounting side of your project immensely.

– Advertising (of token)

The language you use to refer to your token may have an impact on whether your token is deemed a security. Every promotional material you use for your ICO can and will get examined, so it’s crucial that no language misrepresents your offering.

Jargon and technical language won’t protect you. Everything you write can be scrutinized. (Including, social media, Reddit, messaging apps, etc.).

To protect yourself, be sure to set specific guidelines on how to refer to your token from the beginning and make sure that your team members follow diligently. It is always a good idea to seek the counsel of a lawyer to review all of your promotional documents, your website, token terms, and any other material.

When it comes to the legal aspects of your blockchain project and ICO you can never be too careful. There are many shortcuts and ways to bend the rules, but on the long run, this will mostly generate more problems than solutions.

With new tokens and cryptocurrencies going mainstream, and with the huge influx of money the industry has seen lately, I expect that more and better guidelines and legislation will appear. In the meantime, be sure to comply with the current ones and get professional advice to be in control of all of the above.

Key points:

1. Developments in the blockchain space have occurred more rapidly than most legislators can handle. Hence regulations are not up to date with emerging blockchain business and financing models.

2. While specific regulations are still being developed, founders should be wary and conduct their operations with the utmost care by complying with current legislation as much as possible.

3. The minimum aspects of compliance to be addressed concern corporate formation, securities laws, AML & KYC laws, taxation, and the advertising of tokens. There are, however, many other aspects that need to be examined by founders and professional counsel.

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For more details on each of the steps and more in-depth explanations download our “How to Launch an Initial Coin Offering” comprehensive guide.

If you’re planning an ICO, Token Deck is our Initial Coin Offering solution that makes the ICO process safe, compliant and easy. Check it out!

If you have any questions or would like to connect you can find me on Twitter or email me at [email protected] I’m always interested in meeting people working, learning, or involved with the blockchain space.

—

Disclaimer This document does not constitute legal or investment advice nor should be taken as such. You should not rely on it and if seeking to do an ICO or any other related activity you should seek separate professional counsel. It is for informational purposes only. Views do not represent the views of my employer, investors, or partners. Furthermore, the blockchain industry and technology is undergoing constant development so this post is intended as a guide at the current moment of publication and the issues and topics, and therefore the guidance, covered are vulnerable to change and development. The reader should bear this in mind when reading.

Also published on Medium.

Welcome to the second part of the How to do an Initial Coin Offering (ICO) series! This post will focus on how to know if your Token is a Security.

Disclaimer: My opinion is not legal advice. I am not a lawyer. This in no way should be considered legal advice, and my views do not represent the views of my employer, investors, or partners. Moreover, nothing written here should be construed as investment advice either — please consult a professional, many of them are pretty cool…

**Update: August 1, 2017. Monetary Authority of Singapore (MAS) Clarifies regulatory position on the offer of digital tokens in Singapore (you will find that this post is consistent with the new guidance in Singapore) end of update**

An Initial Coin Offering or “ICO” is not the first scheme employed for raising capital in a unique way. Many have been devised in the past in an attempt to avoid the application of securities laws.

These schemes have been analyzed by the courts, and in this case, I will compare Singapore and US definitions, to determine whether these novel schemes are “investment contracts,” and therefore “securities”.

The Financial Action Task Force defines cryptocurrency as –

“a digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction. It is not issued nor guaranteed by any jurisdiction, and fulfills the above functions only by agreement within the community of users of the virtual currency.“

The de facto standard ie. American, for understanding if your token is a security is the “Howey Test”, which was created by the US Supreme Court for determining whether or not certain transactions would qualify as “investment contracts.”

Think of this as the: if it walks like a security, and talks like a security, it’s probably a security — test.

It basically breaks down to understanding the nature of your token within the following 4 parameters –

1. Is it an Investment of money?
2. From an expectation of profits?
3. Is it arising from a common enterprise?
4. Is it dependent solely on the efforts of a promoter or third party?

The “investment of money” dictates that the investor commits his or her assets to the enterprise in such a manner as to subject the investor to financial loss.

Although the term “money” is used, this has expanded to include investments in assets other than money. Eg, which means this could be a cryptocurrency as defined by the FATF and by most jurisdictions around the world as a form of “good”, “asset” or “property”

A “common enterprise” means that investors pool their money or assets together to invest in a project and the model concerns whether any profit that comes from the investment is largely or wholly outside of the investor’s control.

If the investor’s own actions largely dictate whether an investment will be profitable, then that investment is probably not a security.

Why this is important

This is important for Initial Coin Offerings/Token Generating Events, as you need to be clear on what your token provides the token holder so that it is clear, easy to understand, and unambiguous for individuals to assess the rights associated with your proposition and platform.

In order to be deemed a security, the offering would have to meet all 4 tenets, and under the legislation, and transactions that do would be considered securities, and therefore subject to certain disclosure and registration requirements, except for securities offered or sold in exempt transactions.

Here is a link to a Howey Test Template developed by Coinbase where you can do your own assessment to see whether or not your token is a security.

In an ICO the promotional materials associated with your sale will be examined in determining whether it is a security, and therefore you should seek the counsel of a lawyer to review all your offering documents, your website, and your token terms so that no language misrepresents what you are offering to your community.

In determining if something is an offering of securities there will be a focus on your materials and how you are promoting your offer eg what the investors are being offered or promised, how the offer is distributed, and the economic inducements held out to the prospect.

If the materials promise things like “great returns” or “guaranteed income”, regulators will almost certainly find the instrument to be a security, and therefore subject to securities regulations in almost all jurisdictions.

A secondary test that is applied in the United States is the “risk capital test” which was formulated to test whether something is a security. Considerations include –

• are funds being raised for a business venture or enterprise
• is the transaction offered indiscriminately to the public at large
• are the investors substantially powerless to effect [sic] the success of the enterprise
• is the investor’s money substantially at risk because it is inadequately secured.[01]

To take a comparative approach, the Singapore regulators have expressed that cryptocurrencies, in and of themselves, will not be considered “securities” under the Securities and Futures Act [02]

“Singapore, like most jurisdictions, does not regulate virtual currencies per se, as these are not considered as securities or legal tender” [03]

“MAS currently does not regulate Bitcoins. They are not legal tender like the notes and coins issued by MAS. They are also not considered securities under the Securities and Futures Act” [04]

This is consistent with Section 2(1) of the SFA, which defines “securities” as;

“inter alia, debentures or stocks issued by governments or private corporations, any right or option or derivative in respect of any such debentures or stocks, any unit in a collective investment scheme, or any unit in a business trust or its derivative.”

Hong Kong has also taken the same stance as many other countries and as defined by the FATF

“bitcoins are not a legal tender, and their value is not backed by any physical items, issuers or the real economy”[05]

“We therefore consider that bitcoins and other kinds of virtual commodities do not qualify to be an e-currency, having regard to their nature and current circulation in Hong Kong.”[06]

“They are, in most cases, be regarded generally as commodities or virtual commodities for individual speculative activities. It is also unlikely that bitcoins, given its circulation, will pose a significant threat on Hong Kong’s financial system.” [07]

As such, the Government does not consider it necessary to introduce at the moment new legislation to regulate trading in such virtual commodities or prohibit people from participating in such activities.[08]

However, with the advent of Ethereum and “Smart Contracts” which allows developers to make more advanced autonomous entities and constructs; new and novel approaches are being attempted without the proper understanding of the laws that they may fall under, precipitated by a lack of clear guidance and active participation by regulators.

Distinct from the purchase and exchange of cryptocurrencies themselves, smart contracts and decentralized autonomous organizations can be designed to mimic regulated investment structures such as ETFs, derivatives, venture capital, or hedge funds in ways that are faster, borderless, and self-executing.

What this means

If you develop a protocol that mimics these types of vehicles, the default securities laws of most jurisdictions will apply, and these cryptocurrency investment products or investment schemes will most definitely fall under securities regulations.

I suspect that in the future these laws will be challenged when the technology gets advanced enough to create autonomous entities on a blockchain that can learn and act, and evolve on their own, but that is a post for another day.

—

Hopefully, this basic introduction on how to know if your Token is a Security will send you off in the right direction. If you want to learn the basics, read my original article – How to do an Initial Coin Offering (ICO).

You can also find part 3 here: How to Choose the Best country for an Initial Coin Offering or Blockchain/Cryptocurrency Startup.

I keep a pretty open door policy to anyone who wants to learn more, just hit me on Twitter, or email me directly with your questions, and I will try to respond, but answers are not guaranteed.

If you’re still having trouble with understanding the blockchain and how it might apply to your project, I suggest you start with my article: How the Blockchain Works

Also published on Medium.

The neoclassical and Keynesian brands of economics have come under increased scrutiny following their failure to explain the 2008 financial crisis and the environmental effects of human-led climate change.

Prominent thinkers in the fields of behavioral science and complexity theory are embracing a more interdisciplinary approach and place their emphasis on network effects, evolutionary mechanisms, and energy systems.

This new intellectual framework is well suited to evaluating proposed pathways to the renewable energy transformation because it aims to understand the true nature of technology and energy as it relates to the economic process. Rather than reducing technology and the environment to externalities, biophysical economics and complexity theory integrate the natural and social sciences while making these variables essential to its models.

It begins by crowning entropy as the driving force of all economic activity. Entropy stipulates that in closed systems, energy always flows from order to disorder in order to reach thermodynamic equilibrium, implying that energy makes a qualitative change towards equal distribution as concentrated sources degrade and distribute evenly.

As it relates to the economic process, humans are concerned with finding ordered sources of energy suitable for use in production and emitting waste as dissipated energy. A lump of coal is considered energy available for immediate use, whereas the heat energy of the ocean, although significant in quantitative terms, is qualitatively impossible to acquire for economic use.

The key limitation is that the entropy process only works in one direction –

you can’t gather the rubber molecules that disperse as your tire degrades on the pavement. You have to get a new tire to replace it, by taking rubber from the environment in its ordered form.

All economic activity, which at its root consists of taking stocks of natural resources and turning them into goods and services, speeds up the entropy process.

All organisms have a process for gathering energy from the environment, using it as an input for some sort of metabolism process, and exhibiting waste as an output. Prehistoric hunter-gatherers relied on the energy easily available and found in nature, just as any other species of organisms would. They collected plants, hunted animals, and made tools using the resources of the environment, which limited the size of human populations to the natural carrying capacity of the surrounding ecosystem.

There was little notion of scarcity as the natural environment was so vast that waste quickly absorbed and plants or animals quickly regenerated.

The machine age and its side effects

Several great leaps forward constituted drastic paradigm shifts in the amount of energy societies were capable of processing. Fire allowed hunter-gatherers to ward off predators and process nutrients more effectively, agriculture gave societies an energy surplus for the first time, and the fossil fuel energy windfall ushered in the machine age and powered the rise of nation-states.

In terms of labor and capital, these innovations generated lots of wealth. The industrial revolution acted as the socioeconomic equivalent of the Big Bang. Developed societies put vast reserves of fossil fuels to use which lead to exponential increases in economic growth, population size, energy throughput, and resource consumption. 

Technological advances have increased the rate and flow of energy, which has lead to higher standards of living but also increased complexity and energy consumption. 

To epitomize the advantages and disadvantages of technology, consider the tractor. To obtain the 2,000 or so calories needed to sustain ourselves on a daily basis, we went from using muscles to hunt deer to processing vast amounts of energy through huge networks of carbon-based infrastructure.

Rather than expend physical energy as a hunter-gather would, the current agricultural system uses fossil fuels as an input for chemical fertilizer, to power the tractor that harvests the produce, to power the devices that make the tractors, create packaging for the food, transport the food and generate electricity to refrigerate the food along the way. This also includes the energy to supply the office space and labor the corporation needs to do its job, supply the office space and labor for the bank that finances this activity, and supply resources for the government agency that regulates this industry.

The invention of the tractor paired one person with a reasonable capital investment to reap crop outputs previously requiring the energy of thousands of workers. If labor represents the human energy put into the production process, and capital represents the financial value of the equipment to increase efficiency, this model neglects to account for the rare earth metals and fossil fuel inputs required to build and operate the equipment. Monetary value moves from retailers to suppliers, producers to consumers, all the while generating wealth for all and circulating through the economy. 

But energy only moves in one direction.

What does this all mean?

The key takeaway from this energy-centric view of history is that there are two economies. One relates to the physical materials used to make products and move stuff around, like fossil fuels and minerals, and the other relates to imaginary social innovations like paper money and laws that allow us to efficiency organize this energy surplus. But these two systems are diverging. We have an oversaturation of lawyers and bankers, which leads to paper wealth but strains the energy supply – the heartbeat of the economy.  

We are headed towards a fundamental phase shift as Energy Returns On Energy Invested (EROEI) continues to drop. EROEI simply measures the energy required to obtain more energy, with the surplus leftover for rest of the economy. It wouldn’t make sense to drill for oil if all that oil is needed to run the rig.

The problem is, EROEI is on the decline. Drilling oil used to be as simple as sticking a straw in the ground, but now we need highly complex machines to extract crude from tar sands or run offshore rigs. Remember, energy inputs also include all the financial and manufacturing resources required to operate this technology.  

In classical economics, the returns to scale realized by massive corporations and the specialization of labor they facilitate leads to incredible efficiency and profits; in the entropic worldview championed by the biophysical economists, however, this process serves to move civilization further away from thermodynamic equilibrium.

EROEI doesn’t get accounted for in our current production functions and corporate expense statements. To the existing Keynesian paradigm, energy is energy no matter where it comes from. To the biophysical economist, the source is the core measure of economic health.

Declining EROEI

Declining EROEI suggests civilization is on the verge of a transition to new sources of energy. Cheap debt, low interest rates, and inflation have created disequilibrium between the financial economy and the physical economy it was designed to serve. Financialization papers over the genuine health of the economy and temporarily protects us from falling EROEI. The boom and bust of the housing market is one recent example of bankers and lawyers conjuring up wealth in the imaginary economy.

Financial and legal institutions of the imaginary economy evolve around energy sources and technology to form techno-economic paradigms. Originating from Joseph Schumpeter of the Austrian school, techno-economic paradigms represent clusters of disruptive technologies forming a complex system where feedback loops incentivize the diffusion of core innovations. Waves of innovations dominate economies over time and create a common-sense basis for organizing institutions. The institutions, however, are sticky. Laws can’t adapt as quickly as firms can invent engines and semiconductors.

The natural characteristics of the energy source fueling the production process influence the direction and logic of techno-economic paradigms, including financial, legal, and political institutions. Empires couldn’t exist without agriculture, industrial nation-states couldn’t exist without fossil fuels, and paper money originated to account for capital goods from an energy surplus.

Shifting paradigms & redesigning institutions

Renewable energy is naturally distributed and intermittent, so the techno-economic paradigm and its corresponding institutions must evolve to accommodate these facts; moving away from the industrial paradigm towards the information paradigm requires redesigning institutions.

Blockchain technology, as the next iteration of the Internet, can create a software infrastructure layer incentivizing the adoption of renewables and energy efficiency while creating institutions molded for the age of 1s and 0s rather than coal and steam. It can bring us closer to natural order by again synching economic activity with the complex choreography of the biosphere.

We live in an economy where we are always encouraged to consume more and buy things rather than save money and live efficiently because institutions have evolved to maximize the throughput of fossil fuels. Legitimacy depends on the ability to provide economic growth, which is problematic because economic growth is so closely correlated to energy and resource consumption.

Leaping a socioeconomic class literally means owning a bigger house, a car, and using more energy. Everything is organized towards growth.

Although climate change is extremely complex and multifaceted, electricity generation is the best place to start for bringing renewable energy technology to market because it has been the economic sector with the highest emissions. Plus, many solutions for reducing emissions in transportation and heating require electrifying both sectors. This introduces more complexity, digitization, and decentralization onto an electrical grid that still largely functions in the industrial paradigm.

The closer we can geographically place production and consumption of physical resources, the more energy efficient our economy will become. But renewable energy is mostly incompatible with current civilization. Renewables are variable and have low EROEI metrics, while cities and transport are dense. Shifting requires re-organizing economic activity to maximize the strengths and minimize the weaknesses of renewables by creating an Energy Internet with wholesale market prices.

Blockchain & the Renewable Energy Internet

Exposing every node of the digital grid to wholesale market prices will ensure all machines connected to the Energy Internet operate optimally. Poles and wires must act as a platform capable of dispatching and receiving electricity from each grid asset, rather than delivering a product from generation source to customer. It must use every endpoint as either an asset or liability depending on the weather and time of day. By exposing consumers and prosumers to the risk and reward of a market based on the rhythm of natural systems, technology can sync economic energy consumption with the biophysical world.

Blockchain technology is well suited to form the institutional core of this new paradigm by providing financial efficiency and creating a transactive grid.

The current financial system is a centralized vestige of the industrial era ill-suited to finance small-scale energy efficiency and renewable energy projects needed for the energy transition because they have high soft costs. Since the cleantech boom and bust cycle at the beginning of the decade, venture capital firms have been wary of financing startups in this industry. Struggling to operate according to the VC timeline, energy startups have been unable to scale the technologies needed to make meaningful inroads.

Decentralized assets have inherent advantages in liquidity and trading volume because they exist solely in digital form and can travel as fast as the Internet moves 1s and 0s. Through Initial Coin Offerings (ICOs) and tokenized securities, distributed ledger technology can largely address the limitations of venture capital.

When released, tokens are immediately liquid and accessible to patient investors with a timeline suitable for innovation in hard science. Security tokens increase liquidity and reduce soft costs because they remove intermediaries, allow fractional ownership, have instantaneous settlement, and reduce exclusivity.

New & flexible financing mechanisms

Harbor, a startup based in San Francisco, recognizes this market opportunity and uses tokenized securities to automate the institutions responsible for enforcing this conventional financial structure. It combines high liquidity with low administrative burden to remove the illiquidity discount and unlock hidden value by encoding SEC compliant features into the tokens themselves.

Project developers also have struggled to attract the institutional capital needed to deploy high levels of utility-scale wind and solar. For example, solar power projects have rarely met the rigid criteria of institutional investors because they are expensive to securitize, cannot trade on public exchanges, and are not worth extensive due diligence and asset management of large. However, turning cash flows from these solar projects into tokenized securities can reduce institutional costs and create flexible financing mechanisms.

Organizations such as WePower and Impact PPA are working to create more transparency between buyers and sellers to streamline the financial relationship and reduce institutional costs.

An Energy Internet and transactive grid run on blockchain can let the natural order of the market coax out efficient generation, storage, and demand response by tightening feedback loops and creating a market more responsive to the weather. By using blockchains to create a unified Energy Internet operating system, the grid would transform centralized intermediaries into emergent thermodynamic efficiency.

Each node must act in its self-interest based on market signals and be incentivized towards helpful behavior. For example, current flat rate design protects consumers from volatility but does not communicate the value each source of renewables can provide to the grid. Concentrated Solar Power (CSP) plants are currently too expensive, without subsidies, to compete with solar PV, but have the advantage of using molten salt to store energy throughout the night. When markets reward dispatchability, also known as the ability to produce power on demand, CSP becomes competitive.

Startups like Grid+, Powerledger, and Green Energy Exchange are creating networks that lower the cost of peer to peer trading, demand response, and distributed energy resources for individuals, with the ultimate goal of exposing these homes to wholesale markets and reconfiguring how individual entities produce, consume, and trade electricity.

Change will be difficult, impediments are widespread

It goes without saying that there are several impediments to the development of this Energy Internet. On a technical level, it is pretty high profile that distributed ledgers struggle to scale and have poor UX.

Other issues are behavioral; will home and business owners be willing to expose themselves to the volatility of the system? It will be possible if the technology is in place to make sure early adopters and eventually mass consumers have the opportunity to profit. If the products of this techno-economic paradigm, like IoT devices and DERs, are user-friendly, then it is likely individuals will be happy to set preferences and let machines run by smart contracts work markets on their behalf.

Nevertheless, it is clear that embracing a techno-economic paradigm designed to organize economic activity around the decentralized and variable characteristics of renewable energy can be more effectively implemented using blockchain technology.

Kyle graduated from Boston College with a degree in International Political Economy. He enjoys writing about complexity theory, biophysical economics, and the intersection of renewable energy and blockchain technology.

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In nations around the world, the ability of civil servants to do their job is falling behind the problems that must now be faced.

A technologically accelerating and globalized world means government agencies must tackle increasingly complex issues from economic volatility and pandemics to mass migration, money laundering, and terrorism.

In developing nations, an emerging middle-class demand for government services and high population growth have placed acute pressures on civil service.

Outdated and disparate governance systems, widespread corruption and budgetary constraints have led governments to be unable to deliver essential services like healthcare and education to large swathes of the population.

Inadequate record keeping systems have caused citizenry to lack official identification and property rights and resulted in vast informal economies and poverty.

“For he that gets hurt
Will be he who has stalled
There’s a battle outside and it is ragin’
It’ll soon shake your windows and rattle your walls
For the times they are a-changin’” – Bob Dylan 

In developed nations, demographic stresses and aging populations are intensifying pressures on government budgets, forcing civil services to do more with less.

Siloed record keeping systems that lack basic levels of interoperability and transparency have left civil services with a lack of actionable data available for economic, behavioral and infrastructure purposes.

With little meaningful data, governments remain unable to see the bigger picture and make informed decisions that can improve the lives of their citizens.

Antiquated administrative systems at the national and regional levels are also eating away at the ability of governments to react effectively to crisis’ and fight against money laundering, corruption, organized crime, terrorist financing, and other destabilizing forces.

To overcome the complex and diverse impediments to social and economic progress will necessitate governments rearm themselves with new capabilities.

Nations that redesign their governance systems based on blockchain and distributed ledger technologies will be rewarded with a resilient and antifragile digital infrastructure that enables the implementation of more potent government policies which meet the evolving demands of their citizens and deliver stability in a rapidly changing world.

Many problems, one root cause

In developed nations, an aging population presents a real challenge for governments that must find ways to provide an expanded level of services at lower costs.

According to a 2015 report by the United Nations, [1]

• Between 2015 & 2030, those aged over 60 years will grow by 56%
• In 2015, one in eight people worldwide aged 60 or over. By 2030, seniors are projected to account for one in six people globally.
• The aging process is most advanced in Europe & Northern America, where more than one in five people are aged 60 or over as of 2015.
• By 2030, the elderly are expected to account for more than 25% of the populations in Europe and Northern America, 20% in Oceania, 17% in Asia and Latin America and the Caribbean, and 6% in Africa.

In the developing world, challenges center on population increases and economic factors rather than aging. High population growth coupled with a trickle down of innovations is driving a growing middle-class.

Over the next two decades, the world’s middle class will expand by another three billion, with growth coming almost exclusively from emerging nations.[2]

Delivering efficient, sustainable and affordable government services to the world’s aging population and emerging middle class will become increasingly difficult without profound and substantive changes to current systems.

Although the challenges faced by governments are complex and widespread, the vast majority of problems trace back to a single, yet corrosive, root cause.

Fragmented, siloed record keeping systems that lack interoperability have resulted in mismanagement, corruption, waste and a severe lack of advanced data available for economic, behavioral and infrastructure analysis.

Governments today are running blind, unable to meaningfully assess the effectiveness of their services or deal with the changing demands of their citizens.

“Up until now, data in government has been held in isolated line of business applications and used for internal reports. This has created data silos across government leaving valuable data left unused and wasting away in proprietary applications, personal network drives, spreadsheets, databases and emails.”[3]

A supercharged civil service ready to tackle the challenges of today and tomorrow

Blockchain technology can create the resilient digital infrastructure necessary to enable the mass transformation of government administration to occur.

The technology’s decentralized, open & cryptographic nature makes it easier for governments to share data between government institutions and use sovereign data securely.

Real-time analysis of pseudonymous data in transport, security, city planning, health, crime and future proofing give civil service the ability to utilize resources in areas that will have a profound impact on society.

Blockchain technology can also transform civil services by enabling the direct and automatic transfer of payments and other assets between government agencies and citizens for services rendered.[4]

By eliminating excessive intermediary costs and redundancies, government services become more efficient.

Entire government departments could potentially be replaced by blockchain based registries saving billions of dollars of taxpayer funds.

The government land titles office, for example, has the potential to become far more efficient, as new blockchain powered registries immutably record property transactions, ownership, and track provenance.

Overall, by improving the capacity to analyze sovereign data and conduct instant digital asset transfers, blockchain technology can deliver game-changing improvements for governments and their citizenry.

As governing becomes more challenging and public servants are placed under greater public scrutiny, the transformation of civil services must be a top priority for all nations.

With enhanced capabilities, governments raise their nation’s attractiveness and amplify their competitiveness in the new digital economy where human capital and industry are vital to success.

Delivering more scalable public services and unlocking unprecedented wealth

The inability of governments to administer, manage and store official identity records in many developing nations has led to approximately 2.4 billion people today lacking an official identity.[5]

The absence of government-issued identities has, in turn, led to mass poverty, stagnant wealth creation and vast unregulated informal economies.[6]

“The ability to prove your identity is critical to ensure access to educational opportunities, financial services, health and social welfare benefits, economic development, and the right to vote.”[7]

In developed nations, the problems faced by citizens are far less acute. With population-wide documentation and recording of identity from birth, the administering of official identities is not an issue.

Rather it is the fragmented, siloed and disparate identity systems utilized by governments that have led to inefficient public services and unsecured data.

“Local, regional, and national agencies are charged with maintaining records that include, for instance, birth and death dates or information about marital status, business licensing, property transfers, or criminal activity. Managing and using these data can be complicated, even for advanced governments.”

“Some records exist only in paper form, and if changes need to be made in official registries, citizens often must appear in person to do so. Individual agencies tend to build their own silos of data and information-management protocols, which preclude other parts of the government from using them. And, of course, these data must be protected against unauthorized access or manipulation, with no room for error.”[8]

Identity verification has become the central challenge in recent years as governments attempt to digitize public services.

Limitations in digital identity verification have made transacting and interfacing with government services frustrating for citizens who are demanding seamless online experiences.[9]

For example.

Individuals in many first world countries can apply for a new passport online. However, identity verification difficulties result in citizens still being required to print off an application form and return it to the passport office with supporting documents.

The same applies when trying to change a residential address on a driving license.

Data breaches and identity theft is an additional area of concern for governments as the centralized record keeping servers which have been utilized for decades struggle to defend against sophisticated cyber attacks.

“lack of an interoperable and secure identity infrastructure is creating serious friction and in some cases harmful economic and legal distortions that are inhibiting the evolution toward a networked world.”[10]

Yes.

The challenges faced by developed countries are substantially different to those encountered in developing nations.

But the solution to these problems is the same.[11]

Old world record keeping systems used by governments need replacing.

Utilizing distributed ledger technologies like a blockchain can create a cost-effective, decentralized, transparent and incorruptible digital identity ledger that can solve most of the problems faced nations today.[12]

The technology’s permanent and incorruptible nature can eliminate government corruption and mismanagement which have long afflicted much of the developing world.

The rapid verification of licenses, permits, transactions, and identities can be achieved with far greater accuracy, enabling the complete digitization of services and unprecedented efficiencies.

With a blockchain based identity registry, governments have the opportunity to issue e-identities to the population, making the frictionless digital use of a variety of national and municipal services a reality.[13]

Digital ID’s that act as a digital watermark to every transaction will help government agencies check identities in real-time, reducing the rate of fraud and other criminal activities and decreasing the costs associated with the provision of many public services.

Ultimately, the technology’s ability to simplify the management of trusted information and make it easier for government to access and use public sector data while ensuring high levels of security hold profound benefits for civil services. [14]

Perhaps most importantly, with increased levels of data integrity, the relationship between citizens and their governments regarding transparency and trust could be redefined.

Smart contracts introduce game-changing efficiencies in compliance and enforcement

Despite unprecedented regulations and enforcement efforts over the past decade, governments are struggling in their fight against a growing and evolving tide of illicit activities.

Money laundering and terrorist financing are having a corrosive and corrupting impact on society as a whole and now pose a significant threat to the economic stability and security of almost every country in the world. [15]

According to the United Nations, Office on Drugs and Crime (UNODC), Global money laundering transactions estimate at 2 to 5% of global GDP or roughly $1 to 2 trillion annually. [16] Less than 1% of the global proceeds from these criminal activities are seized and frozen. [17]

The reasons for government’s inability to curb money laundering and terrorist financing is two-fold.

New technologies like online casinos and digital currencies are providing alternative pathways for criminals to launder their illegal profits and giving terrorists cover to fund their global activities. [18]

At the same time, authorities don’t have the tools, time or resources needed to identify, investigate and prove complex syndicate activities that can often span several geographic locations and parties.

A failed strategy

Governments of past and present have mistakenly believed that increasing regulations and imposing higher penalties are the keys to winning the battle against crimes that take place in the corridors of the global economy.

The harsh reality is that the regulatory-driven approach used by governments has failed to work in the past and will continue to fail in the future.

This strategy is not only ineffective in fighting crimes like money laundering and terrorist financing, but it is becoming a significant drain on government resources and economic growth.

As the world becomes more globalized and technologically advanced, authorities must ultimately equip themselves with enhanced capabilities or face a worsening state of criminality and instability.

While regulations and harsher penalties do have a role to play, they will only have a limited impact when used on their own.

Effective regulatory compliance and enforcement ultimately require greater transparency, collaboration, and information-sharing which can only be achieved with a new set of supercharged capabilities.

Bringing a tank to a knife fight

Economic volatility, demographic stresses, pandemics, digitization, money laundering and terrorism threaten the stability and future prosperity of all nations.

It’s time for governments to recognize the threats at large and begin investing in the tools necessary to fight the challenges ahead. Small fixes and band-aid solutions will be ineffective and lead to an even more turbulent future.

Blockchain enabled smart contracts can help governments and industry deliver more efficient services, but it can also supercharge government and industry in their fight against money laundering and terrorist financing.

By providing governments and industry with a pseudonymously transparent, unchangeable and tamper-proof platform to store and record all transactions, blockchain technology creates an audit trail that regulators and industry alike can view and act upon in real time. [19]

With immediate access to a system-wide view of transactions, regulators will find it easier to identify suspicious patterns and transactional behaviors.

But that’s not all.

Regulators and industry have the opportunity to become far more potent by capitalizing on the technology’s ability to deliver greater accuracy and timeliness of monitoring activities.

Rules set out by regulators could be hard-coded into a smart contract ensuring automatic compliance with specific AML & CFT regulations and triggering alerts for any predefined suspicious activity. [20]

Compliance officers are also relieved of having to aggregate customer data and painstakingly report their activities on a regular basis. [21]

With hyper-efficiency brought about by smart contract automation in concert with greater accuracy and security, governments gain the agility and robustness needed to overcome an array of serious threats.

The success of nations in the new digital economy depends on a streamlined civil service with supercharged capabilities

Despite significant leaps in technology, the fundamental transformation of civil services has not yet happened.

Government management and administrative systems at the national and regional levels remain relatively untouched by technology and stand ill-equipped to serve the current and future needs of their target populations.

They are eating away at the ability of governments to react to crisis’, fight against money laundering and terrorist financing and deliver cost-effective programs to their citizens.

And so, we have a situation where the very systems designed to assist civil servants to do their job have now become the biggest impediment to their success.

But there is little excuse for inaction. We know the challenges are complicated, however, there is now a promising solution that can tackle these complexities and transform civil services forever.

Governments that embrace blockchain and distributed ledger technologies to reform civil services will get rewarded with a robust and agile digital infrastructure that enables the cultivation of productive ecosystems, better public services, lower costs, and improves sustainable outcomes for all.

Ultimately, a nation’s successful transition into the digital economy and its future competitiveness will depend on a streamlined civil service with renewed and supercharged capabilities.

Find out how blockchain technology can transform global supply chains, insurance, compliance, and national healthcare systems

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Realizing the revolutionary nature of blockchain technology and the existence of a significant knowledge gap among entrepreneurs, industry, and government, Anthony now concentrates his time on creating educational content, researching potential use cases and analyzing the impact of the technology on global industries.

Also published on Medium.

Over the last few years, blockchain and compliance have garnered a lot of attention from companies operating in highly regulated industries.

And for good reason.

Ask any compliance officer about the current regulatory environment and they will likely tell you that we have entered a time of unprecedented risk, uncertainty, and complexity.

Compliance teams face what can only be described as a perfect storm of challenges and are searching for solutions.

A steady increase in regulations combined with unpredictable shifts to existing laws has resulted in an uncertain operating environment. Compliance officers are overloaded, fatigued and struggling to stay abreast of the latest requirements.

Compounding the regulatory uncertainty are greater operational risks. With many companies now operating globally, compliance teams must deal with a broad range of international regulations.

The digitization of global commerce has introduced additional headaches. As consumers shift their activities from the physical to the digital world, the volume and complexity of transactions have significantly increased.

Crimes like fraud and money laundering are reaching epidemic levels and corporate identity management systems, vital to KYC and AML compliance, are proving to be outdated and ill-equipped.

At a time of increased operational risks, regulators have also made it clear that any shortfalls in compliance will result in harsh penalties for companies.

Compliance officers are under the spotlight too.

Increased personal liability stemming from misconduct and negligence has become a top priority for governments following the disastrous 2008 financial crisis.

The decision to hold individuals account for wrongdoings has exacerbated an already severe shortage of experienced compliance officers.

A general tightening of company compliance budgets and a refusal by many corporations to replace inefficient compliance systems has not helped either.

In the face of such profound and wide-ranging challenges, companies that continue to invest in inefficient legacy systems and ‘band-aid solutions’ will find it increasingly difficult to operate, access vital cost savings, develop new products and deliver efficient digital services.

Compliance officers and the companies they work for must confront a different reality that demands more effective and efficient ways of tackling regulatory compliance.

Put simply, the time has come to tame the regulatory beast once and for all.

No more short-term fixes, no more excuses.

But, there is some hope.

Blockchain and compliance are a great match. The technology is showing much promise to fundamentally transform the way companies conduct their compliance-related activities, and as a result, deliver the robustness and agility needed to survive and grow in a more complex digital world.

Meeting security & privacy regulations by offloading control of identity data to customers

The current model of digital identity management, whereby corporations control, verify and store the identity credentials of their customers in siloed, centralized databases is broken and ill-suited to the demands of the digital world.

The digitization of global commerce and the proliferation of technology are changing the demands of identity systems and making it harder for companies to establish and verify identity.[1]

Companies are having to interact with their customers through a range of digital devices resulting in in-person transactions becoming less common and more transactions than ever before involving entities without established relationships. [2]

As companies find it more challenging to establish and verify customer identity, they risk running afoul of strict KYC and AML regulations.

But that’s not all.

The vulnerability of customer information is a major concern as well. Insecure centralized servers used by corporations to store customer data have proven easy targets for criminals to exploit.

“In an increasingly borderless and digital world, privacy and security cannot be ensured through the construction of walls around sensitive information. Identity is the new frontier of privacy and security, where the very nature of entities is what allows them to complete some transactions but be denied from completing others.” – Professor Stephen Saxby, University of Southampton

Massive data breaches and epidemic levels of identity theft and fraud have impacted customers and companies across the world. From Yahoo, and Walmart to Sony and Target, sensitive customer data is being exploited on an unprecedented scale.

“The centralized servers of identity providers like Google and Facebook are honeypots of data, so they’re economically valuable for hackers to attempt to crack.”[3]

So, how can blockchain & distributed ledger technology solve these problems?

Blockchain & distributed ledger technology can replace centralized, corporate-controlled digital identity management systems in with a decentralized infrastructure that increases security and gives control, ownership, and responsibility for identity information to individuals.

This is achieved by shifting trust from corporations, and other third parties to a network agreed incorruptible database. [4] In doing so, companies free themselves from having to issue, verify and store identity data, as the essential element of trust and verification is provided by an immutable and transparent distributed ledger.

Companies can instead verify a customer’s identity by quickly and cheaply checking an industry-specific or nationally distributed ledger. The immediacy and transparency inherent in the technology also mean that any changes to information within a ledger are available in near real time.

With data always under a customer’s control, many of the security and privacy risks that afflict corporate identity providers are eliminated along with most of the costly backend compliance activities.

Why profound change is needed now – offloading a growing burden

We are rapidly approaching a time where the burdens of being an identity provider and data owner outweigh the benefits.

As the volume and complexity of digital transactions increase, corporate verification and identity management systems will increasingly fail and penalties will begin to mount. Outdated identity management systems are set to expose companies and their compliance officers to unprecedented liabilities and reputational damage.

“The upcoming reliance on billions of internet-of-things devices makes it untenable to have all those devices controlled by a centralized identity provider, since a breach of this provider would prove catastrophic to not only digital but also physical infrastructure.”[5]

There are grave concerns about privacy as well. Consumers are becoming wary of security vulnerabilities and are getting increasingly frustrated with companies collecting and selling their data to other unknown entities.

New data protection laws like the EU General Data Protection Regulation (GDPR), set for implementation in 2018, reflect these widespread public concerns and will place companies under a prohibitive new regulatory framework.

“The market opportunity here is precisely this huge because so many organisations are dealing with the digital-identity management challenge according to old ways of thinking. It’s the organisations that can learn to look at digital identity in new ways that will be the winners.” – James Ryan, Consultant, and Co-Founder of Litmus Logic

Rising customer expectations for seamless, omni-channel service delivery will also mean outdated identity management systems will continue to frustrate customers and get in the way of the provision of online services.

Companies that don’t offload the management and control of identity data to customers will find themselves exposed to greater risks and bogged down in more costly and time-consuming compliance related processes.

But the impact could be even worse.

As the volume and complexity of digital transactions increase and new regulations like GDPR take effect, companies that don’t relinquish control of their customer data could, in fact, find their ability to operate diminish to unworkable levels.

Reducing manual compliance processes and eliminating data reconciliation

Know Your Customer (KYC) compliance forms an integral part of the broader anti-money laundering (AML) procedures and regulation set.

Despite the centrality and widening scope of KYC to operations in the global digital economy and the growing risks of non-compliance, companies continue to use outdated and disparate systems.

These systems have made KYC & AML compliance expensive, inefficient and a major hindrance to the delivery of streamlined customer experiences.[6]

“Compliance with AML, Know Your Customer (“KYC”) and sanctions requirements continues to be a key focus area for management, and firms must ensure they are following appropriate compliance procedures to meet the increasing regulatory demands. Firms operating on a global scale must also demonstrate a robust compliance framework, ensuring that each territory has sufficient management oversight and that AML requirements are being adhered to at both a local and global level.”[7]

Today, KYC requirements dictate companies complete several tasks and steps as a part of the onboarding process for new clients. This includes the collection, validation, and verification of key documents such as proof of identity, address, birth, and certificate of incorporation. [8]

It requires compliance officers to manually check and share enormous amounts of data with third parties as well as internal due diligence teams and in some cases can take several months to complete. [9]

Fragmented IT and data architectures have made reconciling data sets across departments a huge headache, especially for large complex organizations.

Banks, for example, do not have a unified KYC system, rather a number of isolated systems which each cover a line of business, such as wealth management and brokerage. [10]

As compliance officers can attest, the management, organization, and integration of these outdated systems are very costly, resulting in companies spending vast sums of money on compliance and causing needless errors and duplications.

The customer onboarding experience is also impacted negatively.

A blockchain of verified customer data would eliminate the need for many of these manual processes as identity data would already exist in a secure and tamper-resistant database. [11]

The existence of a shared ledger would also end the need to conduct costly data reconciliation and reduce errors and duplications as all data is unified.

Any changes made to customer data within the ledger are distributed in almost real time to all members of the network, keeping the information up to date and accurate.

Members would also be able to instantly access certification records of a potential customer by relying on the work another company has already completed. [12]

By reducing the need to conduct manual compliance processes and eliminating data reconciliation, companies can experience a dramatic reduction in compliance costs, including the need to hire costly compliance personnel.

There are huge gains in efficiency to be made, as the time necessary to conduct mandatory KYC and AML compliance processes diminishes.

Compliance teams gain efficiencies in regulatory reporting

A slew of regulations such as Basel II, BRRD (UK, EU), Dodd-Frank (US) and the Bank Secrecy Act (US) are forcing financial firms to dedicate vast resources to ensure compliance and placed an enormous burden on compliance officers.

These regulations and others like them necessitate intensive reporting of counterparty exposures and transactions and the maintaining of customer records to be audited by the government.

Aggregating and automating the large volumes of data required by regulators is, however, problematic and time consuming due to disparate legacy IT systems and siloed record keeping. [13]

“Financial supervision is increasingly driven by data, with regulators requiring data of a greater granularity and at a greater frequency. The type of data needed to assess compliance with the majority of prudential regulations is called “risk data,” which are typically quantitative and need to be of a high quality: structured, well defined, accurate and complete.”[14]

Both industry and regulators win

Blockchain and distributed ledger technology have the potential to remove a number of pain points for both corporations and regulators.

It provides a unified platform to store and record all transactions, a single source of truth that is easily accessible, transparent, unchangeable and tamper proof.

When transactions are executed and validated on a blockchain, they get timestamped and added to an unchangeable chain of blocks in chronological order.

With all transactions documented in a distributed ledger and each time-stamp including a previous time-stamp, a permanent audit trail is created.

The technology ensures that regulators can become part of the transactional process for the first time. With access to all transactions in real time, the process of regulatory reporting is completely transformed.

“By creating a full front-to-back view, banks can better understand the lifecycle of a financial asset and/or contract in a recording-keeping construct that cannot be altered. This full history certainly intrigues regulatory authorities, as it provides full transparency in areas such as “know your customer”, anti-money laundering and transactional data.” [15]

Regulators will not only experience an immediate and more systemic view of transactions, but compliance teams will also be relieved of the burden of having to aggregate data and continuously report their activities. [16]

Perhaps even more profoundly, by providing transparent and immediate access to regulators, blockchain and distributed ledger technology could enable a reduction in systemic risk throughout the financial system and the return of trust to the financial industry and other regulated industries as well.

Smart contracts can automate AML monitoring processes & provide real-time updates

For regulated businesses like financial institutions to remain compliant with anti-money laundering regulations, they are required to assess new clients during the onboarding process and also consistently screen transaction information for any suspicious activity throughout the lifetime of a customer.

The requirement to continuously screen client transactional information requires constant vigilance from compliance officers and make AML monitoring extremely time-consuming and resource intensive.

Beyond the time and monetary costs dedicated to AML compliance, there are also growing questions about the effectiveness of current compliance systems.

In 2014, KPMG estimated that global spending on AML compliance was approximately $10 billion dollars. [17]

Yet according to the United Nations Office on Drugs and Crime, global money laundering transactions remain relatively widespread, making up an estimated 2-5% of global GDP per year. [18]

One of the main reasons for the continued proliferation of money laundering stems from the siloed and disparate information storage systems used by companies today.

These siloed systems that lack basic levels of interoperability result in compliance officers having a piecemeal view of customer activities which severely limits their ability to find and track suspicious activities in a timely manner.

Smart contracts run on a blockchain have the potential to help compliance teams completely automate parts of AML compliance, eliminating many manual and time-consuming processes and improving the accuracy and timeliness of monitoring activities.

With rules hard-coded into a smart contract, companies can ensure automatic compliance with specific regulations and enable an alert for compliance teams for any predefined suspicious activity. [19]

Alerts could even be programmed to automatically produce a Suspicious Activity Report (SAR), which financial institutions must file with the Financial Crimes Enforcement Network. [20]

“Smart contracts represent a next step in the progression of blockchains from a financial transaction protocol to an all-purpose utility. They are pieces of software, not contracts in the legal sense, that extend blockchains’ utility from simply keeping a record of financial transaction entries to automatically implementing terms of multiparty agreements.” [21]

Additionally, smart contracts run on an immutable distributed ledger produce an easily accessible audit trail that regulators and internal due diligence teams could view in real time. [22]

Execution risks could be reduced or even completely eliminated, as the immutable nature of the technology prohibits manipulation and nonperformance.

As operational risks and transaction complexity increases and regulators crack down on compliance, the ability to conduct efficient and effective AML monitoring has become more important than ever before.

Companies that do not employ more effective and efficient ways of conducting AML monitoring will not only continue to drain their resources but also incur costly penalties and severe reputational damage for non-compliance.

Unprecedented risk, uncertainty, and complexity are an unstoppable tide

The high levels of risk, uncertainty, and complexity mean corporations must either make deep transformations to their compliance processes or face an extremely turbulent future.

It is by no means an overstatement to say that compliance challenges now hinder the ability of many companies to develop new products, access important cost savings and deliver efficient digital services.

Faced with the prospect of far-reaching reform and uncertainty over the next few years companies must proactively seek out and implement more effective and efficient ways of tackling regulatory compliance or experience reduced competitiveness in the longer term.

It is no longer enough to spend money hiring more compliance officers or continue investing in outdated systems that cannot handle today’s compliance demands.

“Our survey shows that the old approach of doing the minimum to achieve compliance will no longer be sufficient. Indeed, the findings suggest that banks that fail to take a proactive approach to compliance will be penalised. Although a bare bones approach might save money in the short term, the longer-term impact is that more resources and management time are consumed.” – The Economist Intelligence Unit

The perfect storm of challenges faced by compliance officers requires nothing less than deep technological transformations like those delivered by blockchain and distributed ledger technology.

By helping compliance officers meet looming data security and privacy regulations, reducing manual compliance processes and delivering game-changing efficiencies in regulatory reporting, the technology ensures sweeping benefits. [23]

Armed with supercharged regulatory compliance systems and processes, companies can free themselves from the regulatory burdens associated with identity management and transform their compliance operations into a competitive advantage.

Explore other areas beyond blockchain and compliance by clicking the links below –

• Insurance 
• Healthcare 
• Supply chain

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Realizing the revolutionary nature of blockchain technology and the existence of a significant knowledge gap among entrepreneurs, industry, and government, Anthony now concentrates his time on creating educational content, researching potential use cases and analyzing the impact of the technology on global industries.

Also published on Medium.