The Seasteading Institute was the toast of tech entrepreneurs when it received financial backing from venture capitalist Peter Thiel in 2008. Its mission was to build a manmade island nation where inventors could work free of heavy-handed government interference. One early rendering shows an island raised on concrete stilts in eerily calm waters. The buildings atop the platform resemble nothing so much as the swanky tech campus of an entrepreneur's ultimate dream: No sign of land or civilization in sight. The island, despite appearing strapped for square footage, has room for a full-size swimming pool with deck lounges.

In a 2009 essay, Thiel described these island paradises as a potential “escape from politics in all its forms.” It wasn't just desirable, he said. It seemed possible. “We may have reached the stage at which it is economically feasible, or where it will soon be feasible,” he wrote.

More than a half-decade later, the dream has yet to be realized. And optimism is starting to waver. Earlier this year, during a talk at George Mason University, Thiel said, “I’m not exactly sure that I’m going to succeed in building a libertarian utopia any time soon.” Part of the problem: A truly self-sufficient society might exceed the range even of Thiel's fortune. “You need to have a version where you could get started with a budget of less than $50 billion,” he said.

'I hope all of these people who want to live in an unregulated island paradise get their island, because then they’ll stop complaining so much.' Sam Altman

For its part, The Seasteading Institute has also come to appreciate that the middle of the ocean is less inviting than early renderings suggest. It now hopes to find shelter in calmer, government-regulated waters. According to its most recent vision statement, “The high cost of open ocean engineering serves as a large barrier to entry and hinders entrepreneurship in international waters. This has led us to look for cost-reducing solutions within the territorial waters of a host nation.”

Thiel’s reassessment marks a clear departure from tech culture’s unflinching confidence in its ability to self-govern. In recent years a number of prominent entrepreneurs have urged Silicon Valley to create a less inhibited place for its work. Larry Page called on technologists to “set aside a small part of the world” to test new ideas. Elon Musk has aimed at colonizing Mars. And venture capitalist Tim Draper made a proposal to divide Silicon Valley into its own state. But aside from the continued growth of full-service tech campuses such as Google's and Facebook's, very little has been accomplished in the way of true societal independence.

Building a government, it turns out, is a more complex challenge than much of Silicon Valley would have you believe. Now, Thiel and other high-profile Silicon Valley investors are carefully taking stock of the anti-government view they helped popularize. For all Thiel’s open criticism of elected officials, he sounded remarkably like a politician recanting false promises on the stage at George Mason. Toward the end of the talk, he reflected for a moment on his early essay on seasteading. “Writing is always such a dangerous thing,” he said. “It was late at night. I quickly typed it off.”

Innovation's Dependence on Regulation

One highly visible move toward smoother interactions between government and tech startups came last month when venture capital firm Andreessen Horowitz hired Ted Ullyot, the former general counsel for Facebook, to create a regulatory affairs unit. The announcement stands in stark opposition to a speech delivered by Andreessen Horowitz board partner Balaji Srinivasan just two years ago, when he rallied for tech entrepreneurs to make “the ultimate exit” and form a society of their own.

Some investors see tech culture’s popular stance against regulation as counterproductive. Sam Altman, the president of Y Combinator, says, “I hope all of these people who want to live in an unregulated island paradise get their island, because then they’ll stop complaining so much.” To Altman, regulators are too quickly dismissed as an obstacle to innovation, which overlooks the role of government in helping startups succeed. This outlook contrasts sharply with the dominant narrative that defines billion-dollar-plus startups such as Uber and Airbnb. Their rise is understood as a function of their willingness to defy government. In this storyline, regulators are purely adversaries.

But such a view discounts the essential support that government provides, says Jim Dempsey, the executive director of the Berkeley Center for Law and Technology. Dempsey argues there should be greater recognition of the extent to which startups benefit from government infrastructure. “I can guarantee that if you don’t have a legal structure you will not have innovation,” he says. “Instead you will have chaos.” In every sector of technology, bodies of law allow entrepreneurs to thrive, Dempsey points out. “Why do people feel perfectly comfortable forming a startup when they know that 90 percent of them fail? Because they know that corporate laws and bankruptcy laws protect them from personal liability. They know that they won’t lose their house if the company goes bust.”

'I can guarantee that if you don’t have a legal structure you will not have innovation.' Jim Dempsey

Some of the most explosive tech companies today benefit intensely from various pockets of regulation: Spotify and Netflix (without copyright law, for instance, no one would pay for those services); Lyft and Uber (ever been to a country without paved roads?); Stripe, Square, and even much of Mr. Thiel’s early success at PayPal (without SEC regulations to limit our financial losses on identity theft, who would so freely hand out their credit card information?). And don't forget the Internet itself, which began as a scientific communications network started by the government.

“Entrepreneurs have long complained that they just want to innovate and have the government stay out of the way,” says Dempsey. “Of course, the fact is, every innovator survives on the oxygen of multiple regulatory systems.” But that can be easy to ignore when building something new inevitably leads to legal friction—particularly with regulations that fail to account for the ways technology will continue to evolve.

A nuclear energy startup, UPower, which Y Combinator funded last year, has limited the scope of its testing to countries that have the regulatory framework in place to support them. The small reactors they hope to build have the potential to recycle nuclear waste and operate more efficiently than current plants—using what could be a far safer design.

Jacob DeWitte, a co-founder of UPower and nuclear engineer who studied at MIT, has attracted customer interest from countries in South America that, unfortunately, lack the infrastructure for a nuclear power project. As a result, UPower is looking to find customers in places like Canada and the US, where an established framework provides crucial guidance for such a small startup. “There’s a lot of value in having a regulatory system that helps you formalize the process,” says DeWitte.

Finding the Gray Space

At the same time, even as startups benefit from government infrastructure, regulators benefit from the pressure of companies who enter into conflict with the law—forcing change to occur.

“That’s the nature of innovation,” says Dempsey. “A product or service will emerge in a gray space or unregulated space where the law is not yet clear. And regulators then eventually assert their jurisdiction, at which point the innovator must respond.”

Investors like Altman see this as a useful pattern. He encourages the startups he advises to seek out those gray spaces where the law is not yet clear or could be improved with the pressure of new technology. “A competitive advantage of most startups is a clever regulatory strategy,” says Altman, who is planning Y Combinator’s first workshop on the topic this summer.

One common criticism of government regulation is that it’s grown so over-burdensome that the “gray spaces” where inventors have traditionally operated are vanishing. Particularly in areas where government involvement is heavy—such as healthcare or energy—there’s a concern that small companies can no longer get a start due to constrictive regulations.

“Bureaucracy overtakes things with no benefit to safety plenty of the time,” says Altman.

Yet he remains optimistic that there’s room for startups to build technology that helps laws evolve. For a number of the companies he’s worked with at Y Combinator this has meant seeking out the countries with a legal framework that allows them to gather the data they need to gain regulatory approval internationally. “It’s sort of cool that there are a range of different regulatory environments and people can make decisions about where they want to go,” says Altman. “If I was developing a drone company I’d go to New Zealand. If I was developing a medical device company I’d go to Europe.”

The "Legal Hack" Fantasy

Patri Friedman, grandson of famed free-market economist Milton Friedman, is the co-founder, chairman, and public face of the board at The Seasteading Institute. For a time, if anyone was going to make the dream of a manmade island for innovators a reality, it was him. Even if that dream is far off, he still believes in the need for a protected space for innovation. No matter how well laws are designed for the future, he says, it’s inevitable that new technology will conflict with existing government. Any new technology will necessarily exist in a gray space. “That would be true even in an ideal system of government. The only way for that not to be the case is if the laws correctly predicted innovation and that’s just not realistic.”

Friedman now works as a software engineer at Google, where he was prior to founding the institute. Over the years, he’s come to appreciate the full complexity of building a country. It’s a pursuit that he sees as parallel to the challenges of building software. “I didn’t go into it thinking that it would be easy to write the perfect laws or that regulators don’t try,” he says. “But when I first started out, I kind of naively thought there would be legal hacks.”

As Friedman learned, there are no hacks—no loopholes to escape the conflict in which government and technology inventors are bound. It’s understandable why finding such a hack is the fantasy of many who build technology. Existing in the gray space of the law is uncomfortable. It requires an incredible amount of work. Building an island nation doesn’t escape government. It only creates another government—and a new set of regulators to challenge. In the paradise that defines itself as an island, the true innovators will build bridges.