Crypto must self-regulate before governments crack down

Self-regulation will be critical to managing the rapidly changing landscape of the cryptocurrency industry to preserve its autonomous, decentralized nature.

Months after the collapse of the Terra ecosystem that drove crypto’s market cap below $1 trillion, the industry is beginning the long process of rebuilding not only trust in retail, but faith in itself. Current market conditions are partly due to structural weaknesses in smart contracts, models and governance processes. This is made clear by the many hacks and exploits that have taken place this year and the proliferation of projects with flawed tokenomics and which are managed through questionable operations.

Implementation of stricter self-regulatory standards will be necessary for the industry to build a sustainable, innovative alternative financial ecosystem. On the other hand, if the industry continues to ignore this issue, it is certain that external regulators will step in, forcing the new system to become centralized to comply with older rules.

Self-regulation can power the next stage of crypto

Self-regulation in various permutations has been successfully implemented in many industries with government oversight, resulting in more leniency in external regulation.

The advertising industry is a good example of the implementation of self-initiated standards to protect users’ privacy. As the Internet industry grew in the 2000s, concerns began to emerge about users’ data being used by third parties without consent. The Federal Trade Commission, a US government agency, proposed online privacy guidelines for the collection and use of users’ data for online behavioral advertising. In response, advertising industry representatives developed a self-regulatory program based on the FTC’s recommendations. The program included “ad opt-ins” to give users more control and autonomy over their data, with the ability to opt out of personalized targeting.

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As a result of continuous proactive efforts by the ad industry, they were able to avoid high external regulation and instead operate with oversight from the FTC. This relationship, where government and industry are aligned, shows that innovation can be encouraged while protecting consumer needs.

Without industry-wide participation, self-regulation is futile

For the crypto industry to be taken seriously in self-regulation, it will require industry-wide participation. An article published in the American Political Science Review shows that when it is high self-regulatory participation, intervention from pro-regulatory forces is significantly reduced. Meanwhile, pro-regulatory forces dominated 68% of the cases where there were no self-regulation. Cases with high participation in the number of self-regulating companies with extensive self-regulatory practices caused pro-regulatory forces to drop to 4%.

Good self-regulation can maintain the values ​​of decentralized finance – such as being permissionless – while protecting users.

One area where self-regulation will be crucial is privacy in DeFi. All individuals deserve privacy over their information as well as their money. However, private financial systems are known to be used by malicious actors, leading to actions such as the sanctions against Tornado Cash.

An example of a self-regulating privacy solution would be the creation of opt-in whitelists in private DeFi systems. As a user, you will be able to choose to sign up for one of many possible whitelist services when you deposit and trade in private DeFi. This means that although you will not be personally identifiable, when you later wanted to send funds to a centralized exchange, or sell your assets, anyone would be able to verify that your funds were previously registered on a whitelist, and therefore that your source to funds was not criminal. This whitelist provider can be a centralized exchange, a public organization or an independent third party where you have completed the Know Your Customer requirements.

As a user, you can, if you wish, still choose not to register with a whitelist, or to register with a less reliable one. But this will make it difficult to ever prove the source of your funds or move them back into the traditional financial system.

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The crypto industry has matured significantly with each cycle, proving that its resilience and optimism can evolve. The industry has come together to improve privacy with zero-knowledge proofs, create cheaper and faster options for users through layer-2 solutions and alternative layer-1 blockchains, and compensate users who were victims of hacks and failed projects.

If the industry is to continue to drive development roadmaps without undue regulation, autonomy must be achieved. The tide may begin to turn as more governments weigh in, as we saw in the sanctioning of Tornado Cash and the proposed two-year ban on algorithmic stablecoins. Although self-regulation can prove challenging to coordinate, in the bigger picture it confirms confidence in governing bodies that the industry is taking proactive measures to address its vulnerabilities. That leaves a door open to the possibility of working with regulators to preserve the identity of crypto that drew so many in: economic autonomy and inclusion.

To be sure, these practices may appear to resemble practices in Web2 that implement certain centralizing features. However, the application of these standards by parties invested in the ethos of the industry may be the silver lining that is needed.

Self-regulation will be an important approach to managing the evolving landscape of the crypto industry. The extent of innovation that is possible and conversely the enforcement of government regulations will be reflected by how well the industry proactively regulates itself. To usher in a new era of sustainable growth shaped by those who truly understand what the crypto industry wants to be and where it is going, real fundamental change and self-regulation must be prioritized.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.