As blockchain technology continues its rapid development with respect to the Internet of Value, the Internet of Things, smart contracts and the Internet of Energy (also known as the Enernet), government regulation faces the increasingly daunting challenge of trying to keep pace.

But this challenge grows even more formidable when one considers that it is not just the federal government trying to keep up; several states have explored regulatory policy for blockchain and virtual currency as well.

Government always lags technology. Bureaucracies have ingrained static thinking while the pace of innovation in the private financial tech sector is astonishingly dynamic. But in terms of IoV and other innovations to speed up the movement of money around the world, blockchain technology particularly defies the ability of state governments to regulate constructively and efficiently.

Nearly every state has money transmitter licensing laws intended primarily to protect consumers, especially persons who do not have institutional banking relationships. Since there also are persons who do not want to have such relationships often for nefarious reasons, money transmitter licensing is also a law enforcement mechanism. Following the 9/11 tragedy and the launch of the war on terror and the promulgation of the Patriot Act, prosecutorial scrutiny of money transmission became more intense. However, the speed and protective anonymity of blockchains utilizing virtual currencies, which developed several years after the Patriot Act, added significant issues to that law enforcement focus.

It is a fair question to ask whether there should be state regulation of virtual currency. Can states adequately monitor virtual currency companies, which have some similarities to more traditional money transmitters but also notable differences that may require more regulatory sophistication. For one thing, blockchain technology utilizes cryptographic digital assets, i.e. virtual currencies, as security devices. State money transmitter licensing statutes produce licensing fees but, generally, merely ape federal Bank Secrecy Act requirements such as anti-money-laundering and know-your-customer policies along with suspicious activity reporting.

Accordingly, most states have taken a wait-and-see approach with regard to virtual currencies because distributed ledger technology is still evolving and its current applications are limited. An equally valid reason for such an approach is to avoid posing expensive hurdles to innovation in distributed ledger technology development. This essentially is the regulatory approach of the financial center states of California, Delaware and Illinois. But it is not the approach taken by New York State, which in 2016, amid much fanfare, created a Virtual Currency Business Activity licensing regime — known more commonly as the BitLicense.

Other states wisely have not followed New York’s lead, preferring instead to nurture financial tech development rather than discourage it. New York’s new licensing approval process has had the unintended consequence of being too expensive, breeding uncertainty, and subjecting firms to overly lengthy approval procedure.

States should continue to replicate the regulatory posture that greeted the widespread adoption of internet technology in the 1990s. Internet startups were encouraged, resulting in enormous wealth and ancillary government tax revenue, along with worldwide cost-saving efficiencies in all economic sectors. Distributed ledger technology offers a similar global promise that should not be suffocated by premature state regulatory experimentation. While formal regulatory guidance is inevitable and necessary, ideally it would be at the federal level where uniform requirements could be carefully and deliberately constructed without engendering confusing state interpretations.

Meanwhile, two recent developments suggest the federal government is up to the task in providing uniform regulation for virtual currency companies.

In December, the Office of the Comptroller of the Currency formally announced it would consider licenses for financial technology companies that offer bank products and services. Such entities could receive special-purpose national bank charters. This demonstrates that the OCC recognizes that technology-based products and services are the future of banking.

There is a current universe of more than 4,000 fintech companies in the U.S. and U.K. alone with more being formed nearly every day. Many of these entities are competing with chartered banks. The significance of the OCC announcement is that it suggests the agency will engage in an inclusionary, interactive outreach process to establish clear regulatory guidance for fintech innovation. Federal and state-chartered banks do not need to have additional special licenses to engage in distributed ledger activity that features cryptographic assets and wallets. Thus, the special-purpose national bank charters could obviate the need for disparate, fragmented state virtual currency licensing.

The OCC could establish a single regulatory standard that would enhance and accelerate the development of blockchain and the widespread realization of its potential. It might also ensure that established banks and auditing firms would extend services to fintech companies. Currently, uncertain regulation discourages banks and others from working with stand-alone fintech entities. Notwithstanding the OCC’s intentions, fintech entities would continue to have the opportunity to seek state bank charters or to become service providers to already chartered banks.

The other encouraging development occurred last month, when the Depository Trust and Clearing Corp. decided to switch to a distributed ledger technology for every credit default swap trade it oversees. In 2016, DTCC recorded $11 trillion in such swaps, about 80% of the global market. IBM is implementing the project and many of the largest banks in the world are participating. Moving money via a distributed ledger would be the next logical step for DTCC and its supporting consortium of banks.

The DTCC announcement is significant in that it confirms that distributed ledger technology in the context of global finance is no longer an idea but a working reality. The regulatory significance is that since DTCC is a member of the Federal Reserve System, no new regulation is required.

There is not a rationale for states to create new barriers to entry, adding conflict and confusion to disrupt emerging clarity. Government imperatives to create “guardrails” and keep order can be achieved at the federal level. The increasing real time transparency of financial transactions that can be achieved actually will enhance law enforcement while minimizing interference with innovation and economic development.

Peter J. Kiernan

Peter J. Kiernan

Peter J. Kiernan is of counsel at Schiff Hardin in New York and previously served as counsel to former New York Gov. David Paterson. Kiernan represented Ripple in obtaining New York State’s first virtual currency license. The views expressed are his own.