Cryptocurrencies were originally thought of as decentralized networks run by anti-government libertarians that were constantly at odds with regulatory agencies. Ironically, blockchain technology is one of the best tools regulators can use to increase transparency and efficiency. While the first generation blockchain of Bitcoin limited the information able to be exchanged to the unspent transaction amounts available for each account, the invention of smart contracts greatly expanded the possibilities.

What is Smart Regulation?

Smart contracts enable a decentralized self-regulating system that reflects and enforces existing real-world regulation, on-chain; governance without government. They allow second-generation blockchains, such as Ethereum, to document more comprehensive information sets on borderless, distributed ledgers. Government networks can now be programmed to contain various types of information while shortening the distance between legislation and enforcement.

How Does it Work?

Blockchain enables regulators to transpose legal rules into technical rules through Solidity, the programming language of Ethereum. Written code is then uploaded to the Ethereum Virtual Machine, which executes the contracts. The uploaded code is distributed among various nodes, ensuring that every node has an exact copy of the data. Relevant programmed conditions are examined to ensure that the smart contract is fulfilling the rules set by its creator.

Since transaction history is immutable and fully stored on the blockchain, regulatory bodies can use it as a source of truth when verification of a contract’s execution and other details are required. Furthermore, bad actors cannot come in and change any aspect of a contract at a different point in time. Since execution of the contract is not predicated on any one central system, bad actors also cannot change the execution protocols or attack a single point of failure to void or destroy the contract. This opens a world of possible applications for governments such as:

Anti-Money Laundering (AML): Compliance violations could be caught by regulators in real time allowing for swift action as all reporting and communication would be streamlined. This would not only increase the speed of detection, but also greatly reduce the amount of violations that are never even discovered.

Voting: Voting is a process central to the function of many governments. However, it is highly prone to manipulation. The immutability of blockchain could eliminate problems such as ballot stuffing, double counting, and other types of voter fraud.

Taxation: The tax process involves collection of funds from the public and distribution of those funds among various government programs. Smart regulation would enable automatic collection and distribution of such payments. Furthermore, it would also empower citizens by allowing them to see exactly how their government is appropriating their hard earned money.

Identity Verification: From opening a new bank account to getting into a bar, proof of identity is a central part of everyday life. However, identity is often compromised or stolen with central data storages acting as farms ripe for harvest to the right hacker. The decentralized nature of blockchain can help prevent such malicious attacks from occurring.

Ownership Transfer: Blockchain can also help cut out middlemen that are synonymous with the snail like nature that defines bureaucracies. From buying property to selling a car, blockchain would make records readily available for relevant parties, executing title transfers automatically and cutting out all middlemen from the process.

Obstacles Along the Way

Not all regulatory frameworks are created equally. In an increasingly interconnected world, the weakest link in the regulatory chain risks compromising the entire system. Legislation cannot be enforced effectively unless supervisory bodies monitor cross-border offenders by entering into surveillance sharing agreements with one another. According to a study by the International Monetary Fund, variability in factors such as the level of a country’s economic development all play a part in defining the regulatory structure for each country. For example: While strict Know Your Customer (KYC) legislation prevents suspicious entities from accessing the US financial system directly, money flowing through seemingly legitimate European Union banks can endanger the systems these anti-money laundering laws are supposed to protect.

Proponents of permissionless networks often point to the superiority of cryptography and code over human systems when it comes to regulating an economy. It is natural for regulators to resist the proliferation of such networks over which they exercise little oversight. Yet by painting with too wide of a regulatory brush, these agencies risk forfeiting the opportunity to put this technology to use in vital matters. If regulatory agencies and corporate compliance officers embrace smart contract technology as a means of automating compliance and streamlining processes such as KYC/AML, they can create synergies which will serve to optimize these institutions like never before.